QUALITY ASSURANCEQuality Assurance Report 2017 The scope of each review includes obtaining an...

REPORT 2017

QUALITYASSURANCE

CONTENTS

Foreword

Oversight of our work 1

Our work and review outcomes

Practice review programme 2

Professional standards monitoring programme 13

Our findings

Practice review programme 18

Professional standards monitoring programme 33

Communication with members 55

Annex:

Members of the Regulatory Oversight Board in 2017 56

Members of the Practice Review Committee in 2017 57

Members of the Professional Standards Monitoring Expert Panel in 2017 58

Foreword

Another year has quickly passed and we have completed one more year of our revised practice review and professional standards monitoring programmes. This report provides you with information about our work achievements and common findings identified under our two programmes in 2017 and our future plans.

We have again met our targeted number of practice reviews in 2017 despite our tight resources. As we have covered almost all practices that are given priority for reviews because they have listed or regulated clients or meet our pre-determined risk factors, we expect to do gradually more reviews on practices with normal risk profiles, usually smaller practices, in the next few years. We shall therefore be doing increasingly more desktop reviews although full scope (on site) reviews will still be the largest number of our reviews. In 2017, we developed a plan to shorten our review cycle for practices without listed clients to 6 years and hope to be able to achieve it in three years’ time. A cycle of 6 years is the benchmark used by many overseas regulators for similar reviews and we consider that having a fixed year review cycle would help set expectations and make practices better maintain their quality.

We believe that the effects of our efforts to implement various initiatives to enhance audit quality over the last few years are becoming more apparent as the percentage of closed cases has increased significantly from 56% in 2016 to 75% in 2017. Although the common findings identified in 2017 are more or less the same as previous years, the significance of many of those deficiencies has been reduced. For example we now very seldom see a practice that has not done a monitoring review, although we still hope to see more improvement in the quality of those reviews. Practices are now putting more efforts to address findings before the practice review is closed. The increase in practice review follow up visit and complaint cases in the past few years could be a contributing factor as practices are well aware that we now have less tolerance for practices not showing commitment to audit quality.

In 2017, the Mainland MOF again helped us review five cross border engagements. We thank the MOF for the support that it has given us and hope to be able to establish a mutually agreed approach with the MOF shortly to deal with access to working papers of cross border engagements.

As for professional standards monitoring, the findings identified in 2017 were mostly the same deficiencies as encountered in the past as there were no major changes to financial reporting standards in the last two years. However, 2018 will be a challenging year for preparers and auditors of financial standards as two new standards (i.e. one on revenue and the other on financial instruments) that will require some significant changes to the accounting in the relevant areas have come into effect. We shall cover a review of the application of these new standards in our future review work as application of new standards is a focus of our programme.

In January 2018, the Hong Kong government gazetted the Financial Reporting Council (Amendment) Bill 2018 which will establish the FRC as a fully fledged regulator of listed entity auditors and proposes transfer of responsibilities for practice reviews of listed engagements to the FRC. The FRC Bill has a proposed commencement date of 1 August 2019. We have anticipated this development for some time and have built in our assessment of the effect of the changes into our future work plans. We will continue to be responsible for regulation of all non-listed company auditors and audits so the Institute will retain a key role in ensuring that confidence in the quality of services provided by our members is maintained and valued.

Finally, I would like to take this opportunity to thank once again all practices and members for their support and cooperation in our reviews. I hope, with all our efforts, we are able to see even better review outcomes this year.

Elsa HoDirector, Quality AssuranceMarch 2018

1Hong Kong Institute of CPAsQuality Assurance Report 2017

Oversight of our work

The Quality Assurance Department (“QAD”) has two areas of responsibility, practice review and professional

standards monitoring.

The responsibility for oversight of QAD activities rests with the Regulatory Oversight Board (“ROB”) which

oversees all the regulatory functions of the Institute.

The ROB ensures that QAD activities are carried out in accordance with strategies and policies determined by

the Council of the Institute and in the public interest. The oversight work includes receiving and reviewing

annual work plans and budgets and regular progress reports from management and reporting to the Council

on observations and views in relation to performance and operations. Please refer to Annex for members of

the ROB in 2017.

2 Hong Kong Institute of CPAsQuality Assurance Report 2017

Our work and review outcomes – Practice review programme

Practice review is a quality assurance programme that monitors all the Institute’s practising certificate holders

who engage in the provision of audit and other related assurance services. The Professional Accountants

Ordinance (“PAO”) has empowered the Institute to carry out practice review since 1992. The approach to

practice review was revised in 2006 to bring it up to international standards and it is regularly amended to

maintain best practice.

The Practice Review Committee (“the PRC”) is a statutory committee responsible for exercising the powers

and duties given to the Institute as the regulator of auditors in Hong Kong under sections 32A to 32I of

the PAO. The QAD reports to the PRC which makes decisions on the results of practice reviews. Section

32A of the PAO stipulates that at least two thirds of the PRC members must hold practising certificates.

The practising members of the PRC are drawn from the full spectrum of audit firms, representing smaller

practices through to the Big Four. The composition of the PRC is reviewed by the Nomination Committee of

the Institute every year to ensure a balanced composition. Please refer to Annex for members of the PRC.


Practices Frequency of review Note

Big Four Annually 1

Practices with a significant number of listed clients

Subject to a full review at least every three years and an interim review during the three-year cycle

2

Other practices with listed clients Subject to a full review at least every three years and an additional interim review if certain risk factors exist

3

Other practices Based on risk profiles and random selection 4

Selection of practices for review is based on their risk profiles, developed using information obtained from

the electronic self-assessment questionnaire (“the EQS”) and other relevant sources. The frequency of

reviews of each type of practices is set out below:

Our work

The practice review process can be divided into three stages:

Stage 1 – Preparation

• Select practice for review

• Agree on visit date and request key documents

• Preliminary assessment of submitted key documents including, if applicable, the completed audit health screening checklist and the self evaluation checklist

Stage 3 – Reporting

• Draft report to practice for formal response

• Review practice’s response

• Submit Reviewer’s report and practice’s response to the PRC for consideration

• Advise practice of the PRC decision

• Monitor follow up action, if needed

Stage 2 – On-site visit / inhouse desktop review

• Opening meeting *

• Conduct interviews *

• Review compliance with HKSQC1 and review selected audit files

• Summarize findings and recommendations

• Exit meeting *

* These procedures, if needed, are carried out by telephone for desktop reviews


Note:

1. This recognizes the significance of listed and other public interest entities in Big 4 client portfolios.

2. Practices with 20 or more listed clients will receive an interim review in addition to a full review every

three years.

3. The three-year review cycle is in line with international best practice. In order to address concerns over

the quality of audits of listed companies by smaller practices, the selection approach has the following

additional elements to increase the frequency of practice reviews of practices with less than 20 listed

clients (“relevant practices”):

a) Relevant practices that take on their first listed audit client will receive a practice review within a year

of the date of the first audit report issued on that listed client.

b) Relevant practices that have more than one listed engagement and have been the subject of a

referral to the Financial Reporting Council (“the FRC”) by the PRC or a complaint raised by the PRC or

the FRC will receive an interim review within the next normal three year cycle.

c) Relevant practices that have significant or regular changes in the number of listed engagements will

receive an interim review within the normal three year cycle.

4. Practices with other public interest clients, for example, banks, insurance companies, securities brokers,

insurance brokers are given priority for reviews. A number of practices are selected for reviews on a

random basis to ensure that all practices will have a chance of being selected. Practices with few audit

clients and without any predetermined risk factors (“small practices”) are selected for desktop reviews.

The Institute has plans to introduce a six-year review cycle for practices without listed clients within

the next few years to improve the effectiveness of the practice review system and to benchmark to the

practice used by many regulators worldwide.


The scope of each review includes obtaining an understanding of the practice’s system of quality control,

assessing compliance with HKSQC1 “Quality Control for Firms that Perform Audits and Reviews of Financial

Statements, and Other Assurance and Related Services Engagements” and the practice’s policies and

procedures, and reviewing completed audit engagements. The extent of review work that the QAD carries

out varies from practice to practice depending on the size of the practice and the nature of its client base.

Desktop reviews are carried out for small practices with no predetermined risk factors. Desktop reviews

take place at the Institute’s office and comprise a review of the latest monitoring report and one audit

engagement. In 2017, an initial self-evaluation process was introduced as part of the desktop reviews for low

risk practices with only a handful of private audit clients.

Matters identified during a review are fully discussed with the practice. The QAD is responsible for drawing

conclusions and making recommendations to the PRC for consideration and decisions. The PRC having

regard to the report and any response by the practice to the matters raised in the report may act under the

power given by the PAO, to:

• conclude a practice review with no follow up action required (“direct closed”);

• make recommendations and specific requests to a practice, e.g. submission of a status report, to ensure

appropriate follow up action is taken to address weaknesses and shortcomings (“required follow up

action”);

• instruct that another visit is required (“required follow up visit”); or

• make a complaint to initiate disciplinary action.

Each practice is sent a formal notification of the PRC decision. The QAD monitors the progress of actions

undertaken by practices at the direction of the PRC.

If an auditing, reporting or relevant irregularity is identified in respect of a listed company, the PRC may, via

the Council of the Institute, refer the case to the FRC for investigation.


No. of practice reviews carried out

0

50

100

150

200

250

300

350

5 initial visits

1 follow upvisit

No. of desktop reviews

No. of follow up visits

No. of initial visits

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

82

134

9

152

13

181

15

201

13

206

11

202

107

205

6

42

208

8

46

209

5

78

Our review outcomes

The number of reviews carried out each year has increased from 83 in 2008 to 292 in 2017. The increase in

the number of reviews in 2017 was mainly due to the increase in the number of desktop reviews.


Reviews of practices with listed clients since 2007

Direct closed

Required follow up action

Required follow up visit

Referred to compliance department and the FRC

137 reviews49%

99 reviews36%

27 reviews10%

15 reviews5%

In 2017, the QAD carried out 27 visits to practices with listed clients. We referred five cross border

engagements to the Ministry of Finance (“MOF”) in Mainland China for review. The MOF’s review reports

and the responses from the practices formed part of the practice review reports on the practices. The

Institute will continue to work with the MOF to enhance cooperation and coordination of review work on

cross border engagements.

Since the launch of the revised practice review programme in 2007 up to December 2017, the QAD has

performed 278 reviews of practices with listed clients covering 101 individual practices. For practices with

listed clients where significant findings were identified, the PRC directed the QAD to conduct follow up

actions or visits to ensure that findings had been properly addressed. The PRC has a policy to consider referral

of significant findings identified in an audit engagement of a listed client to the FRC for further investigation.

In the case that there is sufficient evidence of a significant audit failure, the PRC will consider raising a direct

complaint as well. If the PRC decided to raise a direct complaint, the FRC will be notified of the decision.

Up to December 2017, a total of thirteen cases from reviews of twelve practices with listed clients have

been referred to the FRC for investigation. Five investigations resulted in complaints and disciplinary actions

against the relevant practices as a result of serious non-compliance with professional standards and serious

technical failings. Three cases are still under investigation by the FRC. The remaining five cases are under

consideration by the Institute for further regulatory action following the FRC investigations. In addition, three

direct complaints against practices with listed clients were raised by the PRC.


80%

70%

60%

50%

40%

30%

20%

10%

0%2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Practice review cases reported to PRC (all practices)

Direct closed



Direct complaints and/or referrals to the FRC

The PRC met on ten occasions in 2017 and considered 261 practice review reports. The PRC concluded that

196 initial visits should be closed without requiring any follow up actions. For 54 initial visits, practices were

required to undertake specific remedial actions and / or submit a status report on actions taken in response

to practice review findings. Seven reviews required a follow up visit to assess the effectiveness of remedial

actions taken. Four reviews of practices with listed clients proceeded to complaints and / or referrals to the

FRC.

Four follow up visits were reported to the PRC in 2017. One follow up visit was closed on the basis that

adequate remedial actions had been taken, two required further follow up actions and, one required another

follow up visit.

Initial practice reviews reported to the PRC, which were directly closed, increased from 56% in 2016 to 75%

in 2017. The improving results were mainly due to the steps that were implemented in the past few years to

encourage practices to improve their audit quality and better prepare for a practice review and better efforts

made by practices to promptly address the deficiencies identified in the practice reviews.


80%

70%

60%

50%

40%

30%

20%

10%

0%2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Practice review cases reported to PRC (Practices with listed clients)

Direct closed



Direct complaints and/or referrals to the FRC

For practices with listed clients, directly closed reviews have increased from 50% in 2016 to 69% in 2017

while reviews requiring follow up action have decreased from 45% in 2016 to 16% in 2017. This is

encouraging as the outcomes indicate improvement in the general quality of practices with listed clients.

However, in 2017, we also encountered specific cases that required us to take more robust actions. The PRC

directed one follow up visit to a practice with listed clients. Two practices with listed clients proceeded to a

complaint. A separate complaint was also raised against the external engagement quality control (“EQC”)

reviewer from one of these practices due to his failure to act diligently in his role as the EQC reviewer. These

two practices each have only one or a few listed clients. The results of reviews suggest that audits of listed

entities demand a much higher level of resources and technical knowledge than some of the practices had

anticipated.

In addition, two listed entity audits of another two practices were referred to the FRC. In both cases, the

clients had entered into complex financial instrument transactions and the auditors did not perform sufficient

audit procedures to assess the appropriateness of the related accounting treatments.


Practice review cases reported to PRC (other practices)

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%2008 2009 2010 2011 2012 2013 2014 2015

Direct closed



Direct complaints

20172016

The review outcomes of practices (without listed clients) improved significantly in 2017. 76% of the reviews

of other practices (without listed clients) were directly closed in 2017, representing an increase of 20% from

2016. The reviews that required follow up action have decreased from 38% in 2016 to 21% in 2017. The

improving results reflected the outcomes of the new initiatives introduced in recent years which are set out in

pages 11 to 12 and that practices are generally responsive to practice review findings.

In 2017, no reviews of other practices resulted in complaints being raised by the PRC. However, complaints

against two practitioners were raised by the PRC due to non-compliance with PRC directions to deal with

disputes arising from the inability to arrange a practice review.


New initiatives and measures to uphold quality

In 2017, we see direct closed cases reached the record high of 75%. This was the result of the practices

and the Institute working together to promote quality of the profession. In recent years, we implemented

a number of new initiatives and measures to uphold quality. We also noted that more efforts are made by

practices to prepare for practice reviews and to address deficiencies as soon as they are identified in a practice

review. The following sets out the new initiatives and measures that have been introduced since 2014.

Letter to all practices concerning Top 5 findings

In 2014, a letter was sent to all practices setting out the PRC’s decision to take stronger action against the Top

5 findings (including no or insufficient quality control policies and procedures; no or ineffective monitoring;

unsatisfactory subcontracting arrangements; inappropriate audit methodology; and misuse of modified

opinion). If a practice is found to have made no or little attempt to avoid those common findings, the non-

compliance will be regarded as serious professional misconduct and may result in disciplinary action, even

for a first time review. Since the issue of this letter, a few cases that featured Top 5 findings were referred for

disciplinary actions.

E-Seminar and Audit Health Screening Checklist

In 2014, we started to develop an e-Seminar “Improve audit quality – Practice review and common findings”

and an Audit Health Screening Checklist to help practices identify common deficiencies and take appropriate

actions to address those deficiencies. Practices that are identified to have a certain extent of common

deficiencies by the Audit Health Screening process are notified and their practice review will be deferred

for a short period of time such that they can take appropriate remedial actions to address the deficiencies.

Robust actions will be taken against them if the level of improvement is assessed to be unsatisfactory in their

subsequent practice review. We now include a link in our practice review notification letters to encourage

practices to enroll for the e-Seminar in advance of their practice review so that they can gain knowledge

of how to better prepare for a practice review. The e-Seminar is currently available for subscription at the

Institute’s website and the link is set out below:

http://www.hkicpa.org.hk/en/cpd-and-specialization/

cpd/cpd-and-learning-resource-centre/online-courses/e-seminars/available-courses/

Desktop reviews

In late 2014, we introduced desktop reviews for small practices without any pre-determined risk factors

to better utilize our resources and to enable us to carry out more reviews each year. Desktop reviews take

place at the Institute’s office and entail a review of the latest monitoring report and a selected engagement

of the practice.

After using desktop reviews for a few years, we believe they are effective for reviews of small practices.

In 2017, we reviewed and extended the scope of desktop review to cover more practices without pre-

determined risk factors. We also introduced an initial self evaluation process for low risk practices with only a

handful of private audit clients as part of desktop reviews. A full scope review will however be scheduled for

those practices once their number of clients has reached a certain level.

http://www.hkicpa.org.hk/en/cpd-and-specialization/cpd/cpd-and-learning-resource-centre/online-courses/e-seminars/available-courses/

http://www.hkicpa.org.hk/en/cpd-and-specialization/cpd/cpd-and-learning-resource-centre/online-courses/e-seminars/available-courses/

New elements in the practice review selection process

In 2016, to address concerns over the quality of audits of listed companies, we introduced additional

elements to our selection process to ensure (1) practices are reviewed in the first year after they signed off

audit reports on their first listed audit clients and (2) those practices that are the subjects of recent referrals to

the FRC and complaints and that with significant or regular changes in the number of their listed audit clients

will receive an additional interim review within their normal three-year review cycle. Through these additional

visits, we will check whether practices have the required competency and resources to audit a listed client

and have taken appropriate remedial actions to address deficiencies previously identified in a timely manner.

A six-year review cycle for practices without listed clients

In 2017, we introduced a plan to shorten our review cycle for practices without listed clients to 6 years. We

hope to be able to achieve this target in three years’ time and to complete the reviews of practices that have

not yet been reviewed under the revised practice review programme within that 3-year period. A cycle of

6 years is the benchmark used by many overseas regulators for similar reviews and we believe that having a

fixed year review cycle would help set expectations and make practices better maintain their quality.

Other robust actions

During practice reviews, we encountered cases where working papers and documentation were prepared

or added just before the start of the practice review. It is important to note that HKAS 230 requires

documentation of any changes to working papers subsequent to the completion of file assembly and reasons

for making the changes. Adding working papers in reaction to practice review notification is unprofessional

and unacceptable and creates serious doubts as to whether sufficient and appropriate audit evidence has

been obtained before the audit report is issued. Practices should be aware that if we encounter instances

that suggest that additional working papers have been created for the pre-selected engagements, we will

extend our review scope to spot check additional audit engagements.

Practices are required to complete a practice review electronic self-assessment questionnaire (EQS) every one

to two years. During practice reviews, we also found some practices that had reported false information in

EQS intentionally in an attempt to manipulate the chance of being selected for a practice review. Such acts

raise concerns about the integrity and professional conduct of the practitioners. Practices should be aware

that we will check the information reported in the EQS as part of our standard procedures in a practice

review.

In 2017, we identified a few practices which had added working papers in reaction to practice review

notifications and / or reported false information in EQS intentionally. The PRC decided to take disciplinary

actions against these practices in early 2018.

We shall continue to enhance our review approach and introduce new initiatives and measures with an aim

to promote further improvements in quality of the audit profession.


Our work and review outcomes – Professional standards monitoring programme

The programme is a non-statutory financial

statements review programme set up in 1988 with

the objective to enhance the quality of financial

reporting and the application of professional

standards in Hong Kong. It monitors compliance

with professional standards by members engaged

in the preparation or audit of listed company

financial statements.

Under this programme, the QAD carries out

reviews of Hong Kong listed company financial

statements to identify if there are any matters that

indicate possible non-compliance with professional standards. Enquiry letters are issued to members (primarily

auditors of the listed companies) for the issues identified. Matters raised primarily focus on financial

reporting but the QAD also looks into audit if significant issues are identified. The QAD determines if follow

up actions are required on the issues raised with the auditors based on the reviews of the auditors’ replies

to our enquiry letters. Follow up actions include issuing further enquiry letters and letters with comments

to advise members of areas for future improvement. If the issues identified indicate significant potential

non-compliance with professional standards that constitutes a “Relevant Irregularity” or “Relevant Non-

compliance” as defined under the Financial Reporting Council Ordinance, the financial statements, and

our concerns, will be referred to the Financial Reporting Council (“FRC”) for investigation unless evidence

obtained is sufficient for the QAD to pursue a complaint itself.

Changes are often made to the subsequent financial statements in light of our comment letters. To ensure

that members benefit from our programme so as to enhance the quality of financial reporting in Hong

Kong, the QAD communicates significant or common weaknesses identified from the reviews to members

through different channels such as annual joint financial reporting forums, technical articles published in the

Institute’s publication (A-Plus) and the QAD annual reports.

The programme is supported by the Professional Standards Monitoring Expert Panel (“Expert Panel”) and

independent external reviewers (“Independent Reviewers”). The Expert Panel is an advisory panel that

gives advice to the QAD on the appropriate course of actions on significant, complex or controversial

issues. The Expert Panel in 2017 comprised representatives from the Big Four firms, medium-sized

practising firms and Hong Kong Exchanges and Clearing Limited (“HKEX”). Please refer to Annex for

composition of the Expert Panel.


The Independent Reviewers as well as the QAD are involved in conducting initial reviews of financial

statements. The QAD assesses the observations identified from initial reviews and determines whether an

enquiry should be raised.

The Institute regularly communicates with the FRC and the HKEX which have similar financial reporting

review programmes to avoid duplication of reviews.


Our work

The review process comprises three stages:

Stage 1 – Initial review

• Published financial statements assigned by the QAD to Independent Reviewers for initial reviews

Stage 2 – QAD review

• The QAD reviews observations identified in initial reviews and issues enquiry letters to members when necessary

• The QAD consults the Expert Panel on significant, complex or controversial issues

Stage 3 – Follow up

• In cases where enquiry letters are issued, the QAD reviews reply letters from members and decides whether further enquiry or other appropriate action is necessary

• The QAD consults the Expert Panel on significant, complex or controversial issues

The programme uses a risk-based approach to select financial statements for review. The following chart

shows the basis of selection of financial statements reviewed in 2017.

The category “Companies with primary operations in Mainland China” included some financial statements

which were prepared under China Accounting Standards for Business Enterprises.

Review of initial application of new financial reporting standards is a focus of our programme. However, as

there were no major changes to financial reporting standards in the past two years, only a small portion of

financial statements reviewed were for “Companies affected by new/revised standards” in 2017.


30%(2016: 32%)

1%(2016: 1%)

12%(2016: 12%)

4%(2016: 8%)

10%(2016: 11%)

9%(2016: 11%)

7%(2016: 7%)

27%(2016: 18%)

Basis for selection

Companies with primary operations in Mainland China

Companies affected by new/revised standards

Change in auditors

Change in directors

Newly listed

Active or unusual trading of companies shares

Media coverage relating to the companies

Random


Distribution of auditors in respect of financial statement reviewed

Big 4

Practices with 10 or more listed clients

Practices with less than 10 listed clients53%(2016: 57%)

44%(2016: 37%)

3%(2016: 6%)

The following chart shows the distribution of auditors of the financial statements reviewed in 2017:


Initial reviews

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

No enquiries

Closed with comments

Enquiries made

2016 2017

Our review outcomes

In 2017, the QAD reviewed 70 sets of financial statements reviewed. The QAD also followed up 25 cases

brought forward from the previous year. During the year, the QAD issued 38 letters enquiring about matters

identified from reviews or making recommendations on improvements in presentation and disclosures. The

QAD handled a total of 34 responses from auditors during the year.

The chart below shows that follow up action was not needed for the majority of financial statements

reviewed in 2017.

Referrals are made to the FRC for investigation when the QAD identifies potential significant non-compliance

with professional standards. Since 2010, a total of 14 cases have been referred to the FRC for investigation

of which two cases were referred in 2017.

Our findings

Practice review programme

This is the eleventh annual report on our revised practice

review programme. Every year, we use the annual report

to communicate common findings identified in practice

reviews. To be clear, it is not that all these findings

arise in all practice reviews, but rather these findings

recur more frequently and therefore it is worthwhile

communicating them for practices’ particular attention.

In 2017, significant improvements have been noted in

terms of the efforts made by practices to address the

common findings previously communicated, resulting in

the significant increase in the percentage of closed cases in 2017. However, some of those findings still recur

more often than we would expect to see and therefore more efforts are required from practices to rectify

those deficiencies without delays.

We achieved our target of practice reviews for 2017, having carried out 214 onsite and 78 desktop

reviews, including 5 follow up visits. Most practices were cooperative and willing to make improvements

to their systems, policies and processes to address deficiencies identified in their practice reviews. The

following section sets out the common deficiencies identified during our 2017 practice reviews. You will

note that the common findings are more on the engagement level as the general standards of quality

control have improved.

Common findings on quality control

Fee dependence

Through practice reviews and our regular publications,

smaller practices with one or few listed clients are now

more familiar with the requirements of the Code of

Ethics (“COE”) that deal with situations when the total

fee income from a listed client and its related entities

has exceeded 15% of the total fees received by a

practice for two consecutive years, in particular the safeguards required to reduce the relevant threat to an

acceptable level.


Another fee dependence issue more commonly identified concerns outstanding audit fees brought forward

that remain unpaid at the time when practices issue their current year’s audit reports. Some practices were

not aware that this issue creates independence threats that should be addressed. According to section 290

of the COE, a self-interest threat may be created when fees due from an audit client remain unpaid especially

when a significant part is not paid before the issue of the audit report for the following year. Practices should

assess the significance of related threats and apply appropriate safeguards to eliminate or reduce the self-

interest threats to an acceptable level e.g. having an additional professional accountant who did not take

part in the audit engagement to provide advice or review the work performed. Under the requirement of the

COE, practitioners should also consider whether the overdue fees might be regarded as being equivalent to a

loan to a client and whether, because of the significance of the overdue fees, it is appropriate for them to be

re-appointed or continue with the audit engagements.

File management and assembly

Although a decade has passed since HKSA 230 Audit Documentation became effective, some smaller

practitioners still believed that we would accept oral explanations to support their work. Instances

were found where no working papers were prepared for significant audit areas. Some practitioners,

particularly those sole practitioners without staff, explained to us that they performed all audit procedures

themselves and therefore there was not a real practical need to prepare comprehensive working papers

to record the work done. This is non-compliance with HKSA 230. Documentation on audit files should

be sufficiently detailed to give us a clear understanding of the work performed, the evidence obtained

and the conclusions reached. Practices may provide oral explanations to clarify or explain information in

the documentation. Practices should however document audit evidence, including that contradicts or is

inconsistent with the audit conclusions on significant matters or issues and, where applicable, explain how

they addressed the contradictions in forming the conclusions.

In some cases, practitioners explained that the missing working papers were kept at their home (particularly

for part-time practitioners) or with members of the audit teams, as they were taken out from the relevant

audit files for preparation of the subsequent years’ audits. When there are indications of file management

and assembly issues (e.g. many non-assembled working papers in folders lying around in the office) and/or

we are not convinced with the practitioners’ explanations, we would consider the need to select and review

additional audit engagements on the spot at the practices’ offices for assessing the significance of those

issues and whether they could have other audit implications (e.g. whether audit reports are adequately

supported by sufficient appropriate evidence at the time they are issued).

Robust actions were taken by the Committee against practitioners with serious deficiencies in file

management and assembly and documentary evidence to support that appropriate audit work had been

performed before issue of the audit reports.


IES 8

IES 8 Professional Competence for Engagement Partners Responsible for Audit of Financial Statements

is effective from 1 July 2016. The objective of IES 8 is to establish the professional competence that

practitioners develop and maintain when performing the role of an engagement partner/director.

IES 8 identifies the responsibilities of individuals, firms and professional bodies in developing and maintaining

professional competency of engagement partners/directors. It sets out how engagement partners/directors

should develop and maintain relevant competencies and be able to demonstrate what has been undertaken

by way of learning outcomes.

We noted that many small practitioners were not aware of IES 8 and therefore, did not have policies and

procedures established to ensure the requirements of IES 8 are properly addressed.

Practices are reminded to develop policies and procedures and provide sufficient resources and aids, for

example, training programmes covering learning outcomes required by IES 8, to facilitate individuals

performing the role of an engagement partner/director and maintaining their individual competence and

capabilities necessary to perform engagements in accordance with professional standards.

Engagement partners/directors are reminded to maintain relevant professional competence through CPD,

practical experience and other learning activities to achieve the specified learning outcomes for technical

competence, professional skills and professional values, ethics and attitudes as set out in IES 8.

Common findings on engagements

Modified audit opinions

It is common for practices to modify their first year

audit reports because of the following:

• Clients fail to prepare consolidated financial

statements and practices were unable to

obtain sufficient appropriate evidence on

investments in subsidiaries which were

material to the financial statements;

• Clients did not have complete or proper records for practices to carry out the audit of significant account

balances; and

• Clients did not invite practices to attend the year-end inventory count.



The following common shortcomings were identified when we reviewed qualified opinions on the financial

statements:

• Practices did not consider whether effects of the qualifications on the financial statements were material

and pervasive nor justify why issuing a qualified, instead of a disclaimer or an adverse report, was more

appropriate;

• Practices did not have sufficient documentation of details on file to justify the type of qualified report

issued; and

• Practices issued recurring modified reports that resulted from scope limitations year on year.

When audit qualifications resulting from scope limitations imposed by management had been recurring for

a number of years, we would expect to see evidence on the audit file to demonstrate that the practices had

made efforts to resolve the limitations and had given adequate consideration to the impact of the recurring

audit qualifications on the practices’ ability to continue as clients’ auditors. When there is no such evidence

on file, this could lead to concerns whether adequate steps had been taken to resolve the scope limitations

and also begs a question whether there was a real limitation or it was simply an arrangement of convenience

between client and auditor.

Practices should use best endeavors to obtain sufficient, relevant and reliable audit evidence to enable them

to express an unqualified opinion. Where a scope limitation is truly imposed by a client, practices should

consider alternative audit procedures and should issue a modified opinion only when there are no alternative

procedures or where such alternative procedures fail. Paragraph A9 of HKSA 705 Modifications to the

Opinion in the Independent Auditor’s Report states that limitations imposed by management may have other

implications that need to be addressed by the auditor such as in engagement continuance. Section 410.52

of the COE also states that significant limitations imposed by a client may infringe on the practice’s statutory

duties as auditor. Practices should normally not accept appointment or reappointment as auditor in those

circumstances.

It is unacceptable not to carry out practicable audit procedures when they are available and the reason for

issuing a modified report is merely to save cost and meet the reporting deadline. One review in 2017 where

the practitioner was found to have expressed qualified opinions in most of its reports issued, resulted in a

complaint being raised by the PRC and subsequent disciplinary actions despite it being a first time visit.

Key audit matters (“KAM”)

With effect from 15 December 2016, the content of auditor’s reports issued on a listed company’s financial

statements changed significantly. In particular, practices are required to include a new section on KAM in

the auditor’s report to highlight those matters that, in the auditor’s professional judgment, are of most

significance in the audit of the current year/period.

In our reviews, the following shortcomings were identified regarding the identification and communication

of KAM:

• The audit team did not check the accuracy of the descriptions of audit procedures performed to address

KAM in the audit report, as we discovered inconsistencies between the descriptions in the audit report

and the documentation on file;

• Although there were a few matters identified as potential KAM at audit planning, no documentation

was provided to support why some of those matters were not ultimately communicated as KAM in the

audit report; and

• Audit teams communicated KAM with those charged with governance only at the audit report date.

There was no evidence to show that communication was also conducted earlier, most appropriately at

audit planning.

According to HKSA 701 Communicating Key Audit Matters in the Independent Auditor’s Report, KAM are

selected from matters communicated with those charged with governance and are determined by taking

into account areas of higher risk and significant auditor judgement, and the effect on the audit of significant

events or transactions. In most cases, KAM relate to significant complex matters disclosed in the financial

statements, e.g. valuation of goodwill and other long-term assets, valuation of financial instruments, or

accounting for significant acquisitions. In describing KAM in the audit report, the auditor is required to

set out the reason a matter is considered a KAM and how the auditor deals with the matter. Practitioners

should exercise professional judgement and consider relevant factors in determining whether or not to not

communicate a matter as a KAM.

Audit teams should communicate their preliminary views about KAM when discussing the planned

scope and timing of the audit, and further discuss such matters when communicating audit findings.

Communication with those charged with governance enables them to be made aware of the KAM that audit

teams intend to communicate in the audit report, and provides them with an opportunity to obtain further

clarification where necessary.


Materiality

Materiality is an area to which many small practices still fail to pay enough attention. Common issues

identified in relation to determination and application of materiality were as follows:

• Overall materiality, performance materiality and a clearly trivial amount were not determined at planning

or applied during the audit;

• The materiality computed was not used for determining the nature, timing and extent of audit

procedures;

• Performance materiality was set at an amount larger than overall materiality;

• No documentation was provided to justify the computation of materiality based on the average of the

amounts determined by applying some percentages to different benchmarks (e.g. profit before tax,

gross revenue, gross profit, etc); and

• No documentation was provided to support why the audit team considered the change in the amount

of the chosen benchmark (e.g. profit before tax or total assets) from planning to completion did not

warrant a revision to the materiality and a revisit to the sufficiency of audit work performed.

Practices should determine overall and performance materiality in accordance with HKSA 320 Materiality

in Planning and Performing an Audit, as well as a clearly trivial amount in accordance with HKSA 450

Evaluation of Misstatements Identified during the Audit. According to HKSA 320, practitioners should make

judgements about the size of misstatements that are considered material for an audit. Those judgements

provide a basis for determining the nature, timing and extent of work to be performed.

Fraud risk assessment

HKSA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements requires

practitioners to consider fraud risk in an audit and adopt a more critical and skeptical mind-set particularly

during audit planning and evaluation of audit evidence, to identify, assess and appropriately respond to

fraud risk. However, some practices failed to carry out appropriate work to address some basic requirements

of HKSA 240 and the following deficiencies were still commonly identified in practice reviews:

• Insufficient work on journal entry testing to address fraud risks arising from management override of

controls

During our reviews, we noted that some audit teams:

i) only scrutinized the general ledgers to address the risk of management override of controls;

ii) did not select transactions posted to control or suspense accounts in journal entry testing; or

iii) only tested journal entries above overall materiality to address risk of management override of

controls.


We would like to remind practitioners that, HKSA 240 specifically requires auditors to select journal

entries and other adjustments made at the year-end (for example, non-routine entries; entries/

adjustments made by personnel who typically do not make journal entries; and entries contain round

numbers or consistent ending numbers) and consider the need to test journals and other adjustments

throughout the year. These procedures are necessary as material misstatements of financial statements

due to fraud often involve manipulation of the financial reporting process by using:

i) inappropriate or unauthorized journal entries which may occur throughout the year or at the period

end; or

ii) adjustments to change amounts reported in the financial statements that are not reflected in journal

entries e.g. consolidating adjustments and reclassifications.

Practices should carry out appropriate procedures to address risk of management override of controls

as part of fraud assessment procedures and clearly document details of the procedures performed e.g.

criteria used to identify significant and unusual journal entries and fraud discussions with the audit team

and management.

• No evidence to support that audit teams discussed susceptibility of clients’ financial statements to

material misstatement due to fraud.

HKSA 240 and HKSA 315 require audit teams to discuss susceptibility of an entity’s financial statements’

to material misstatements due to fraud. In planning an audit, the engagement partner/ director and/

or manager should communicate the potential for material misstatements due to fraud with other

members of the audit team. Practices should document the discussions with team members on how

and where the entity might be susceptible to fraud and ensure the appropriate level of professional

skepticism is maintained on those specific areas.

• No or ineffective inquiry of management about fraud when gaining an understanding of the client.

Practices should inquire of management about its knowledge of fraud bearing in mind that auditors’

responsibility for detecting material misstatements caused by fraud is not directed to the detection of

fraudulent activity and the responsibility to detect fraud is framed by the key concepts of materiality and

reasonable assurance.

In a review of a group audit engagement, we noted that the group audit team had performed a legal

search and its results showed that a subsidiary of the client had filed a civil claim as a result of theft by

an employee. However, the group management did not inform the group audit team about this matter

during the fraud enquiry. In this situation, the audit team should have considered making a fraud

enquiry with management of the subsidiary and assessed the implications of this matter for the audit.


In cases where the resulting misstatement from a potential fraud risk matter is not considered to be material

to the financial statements, audit teams should consider referring the matter to an appropriate level of

management at least one level above those involved. If the matter can have a material effect on the financial

statements, audit teams should follow up the matter with an appropriate level of management and then

determine its effect on the financial statements and the auditor’s report.

When performing a listed entity audit, practices should also understand controls and programmes that

management has established to mitigate specific risk factors and assess how well management monitors

those controls and programmes. Those charged with governance in the entity, such as the board of directors

and the audit committee, should assume an active role in oversight of the assessment of the risk of fraud.

Audit teams should obtain an understanding of how the board of directors exercises its oversight activities.

When the client has an internal audit function, the audit team should also inquire of the internal audit team

about their assessment of fraud risk, including whether the management has satisfactorily responded to

internal audit findings during the year.

Evaluation of key internal controls

We continue to find practices, particularly small ones, that did not perform appropriate risk assessment

procedures, in particular on evaluation of the design and implementation of key controls, as required by

HKSA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity

and Its Environment. Typical examples include:

• Documentation briefly recorded that all transactions were approved by the director(s) and there were

no further details of key controls that are specific to the business;

• Documentation showed that the audit team had checked payment and receipt documents to ensure

that the control procedures existed in the business but there were no further details to show how the

related internal control evaluation was performed; or

• Audit teams identified key controls in areas of sales, purchases, payments, receipts and financial

reporting closing process but did not evaluate their design and implementation.

HKSA 315 requires risk assessment procedures to be undertaken regardless of the size and complexity of

the client. Practices are required to obtain an understanding of controls relevant to the audit and perform

appropriate work to evaluate the design and implementation of controls. In smaller and less complex

entities, controls are typically informal and undocumented, and often compromised by a lack of segregation

of duties. However, the involvement of the owner-manager in the day-to-day running of the business can

have both a positive and a negative effect on the evaluation of risk. While the owner-manager’s ability to

closely supervise and oversee the business is potentially a strong control, in some situations this dominance

can lead to the override of controls and the manipulation of financial data and company assets for personal

objectives. Tax implications are usually important to owner-managers and may provide a motive for bias in or

manipulation of the financial statements. Practices need to critically assess risks relating to the completeness

of recorded assets and income when carrying out an audit.


Communication with those charged with governance

Practices with listed company audits were generally well aware of the requirements to communicate the

following with management and those charged with governance:

• Planned scope and timing of audits

• Information about threats to auditors and the safeguards applied

• Significant findings from the audit

Some practices have developed templates to assist audit teams’ communication with audit committees.

However, the templates were not always used properly and therefore audit teams failed to address certain

requirements. Other deficiencies identified in communication with those charged with governance included

the following:

• No evidence of communication with the audit committees (e.g. planned audit scope, written

representations given by the client’s management, key audit matters, etc) including when and to whom

the audit teams had communicated;

• Audit teams did not communicate their planned scope, identified significant risks and timing of the audit

to the audit committees but rather requested management to communicate those matters to the audit

committee members after their audit planning meetings with management;

• Audit documentation did not show whether audit teams had made inquiries of management and

audit committees to determine whether they had knowledge of any actual, suspected or alleged fraud

affecting the client; and

• Audit teams did not (i) disclose fees charged for all professional services provided by the practices or

(ii) provide breakdowns of non-assurance services in their communication with audit committees to

assist audit committees in assessing the effect of provision of non-assurance services on the practices’

independence.

Written communication that usually takes the form of a report to the audit committee provides value to

clients by informing management and those charged with governance about significant matters arising from

the audit so that appropriate action can be taken to address them. Appropriate communication will also help

enhance the general efficiency and effectiveness of an audit.


Audit confirmations

We again identified a number of instances where confirmation requests were arranged by client personnel

e.g. allowing clients to mail confirmation requests. When performing confirmation procedures, practices

should ensure their audit teams adequately control the confirmation process e.g. sending out the

confirmation requests themselves and requesting replies to be sent directly to them. When replies are in

the form of a fax or other electronic means, practices should perform all reasonable steps to verify the

identity of the sender as required by HKSA 505 External Confirmations. A failure to properly assess the

reliability of the confirmations (i.e. ensure they are genuine and from a third party) may result in drawing

wrong conclusions on the matters confirmed.

In some cases, circularization was carried out but there was no proper follow up action, e.g. consideration

of potential implications of information disclosed in bank confirmations. Practices should perform sufficient

alternative audit procedures when confirmations are not returned or are returned with material exceptions.

Audit of construction contracts

Auditing construction contracts can be complex, in particular, when clients used the percentage-of-

completion method to account for long-term contracts. The following deficiencies were identified in audits

of construction contracts:

• The client’s financial statements showed that a debit amount of “increase in recognized profits of

contract in progress” was recognized as other income. The audit team was not aware of the fact that

the treatment of recognizing contract revenue and contract costs on a net basis was not appropriate.

Contract revenue and contract costs associated with a construction contract should be recognized

separately as revenue and costs by reference to the stage of completion of the contract activity at the

balance sheet date;

• Contract revenue and costs were recognized based on settlement dates rather than according to the

stage of completion of the contracts at the year-end date. However, the audit teams did not challenge

their clients’ accounting treatment which does not appear to have complied with the relevant standards;

• Clients did not recognize contract revenue and contract costs in the income statement for contracts

whose outcome could not be reliably estimated. However, the audit teams were not aware that such

treatment did not comply with the relevant standards which require that when the outcome of a

construction contract cannot be estimated reliably, contract revenue should be recognized to the extent

of contract costs incurred that is probable to be recovered and contract costs should be recognized as an

expense in the period in which they are incurred;

• No audit work was performed to assess effects of variation orders on projects that might cause changes

to contract revenue and costs;


• No audit work was performed to verify the estimated total contract costs used to determine the stage

of completion based on the proportion of contract costs incurred for the work performed to date to

the estimated total contract cost. There was also no documentation to show how the contract costs

incurred to date were verified;

• No audit work was performed to assess whether the total contract costs had exceeded total contract

revenue such that expected losses would arise and required to be expensed immediately; and

• Documentation of the contract revenue cut off test showed that the audit team had checked the

projects’ stage of completion to the quantity surveyors’ certified reports issued before the year end, but

it was unclear whether the percentages of completion certified in those reports were up to or close to

the financial year end. The audit team should also consider reviewing the certified reports issued shortly

after the year end to ensure that there were no material issues on cut off of contract revenue and related

contract costs.

Practitioners should be mindful of the above shortcomings when they audit construction contracts.

Audit of inventories

Issues on auditing inventories have been covered in previous reports and forums but still keep recurring year

on year. The following are common deficiencies identified in the audit of inventories:

• Audit teams did not attend the year-end inventory counts without a valid reason to support why such

arrangements were impracticable;

• When the year-end inventory count was carried out at a date other than the year end date, audit teams

failed to perform audit procedures to test transactions during the intervening period to ensure the

movements were properly recorded;

• Audit teams attended the year-end inventory count but did not check whether the count results agreed

with the client’s final inventory records;

• Discrepancies between actual quantities observed by audit teams during the year-end inventory count

and those shown in the final inventory count lists provided by clients were noted but there was no follow

up work by the audit teams to evaluate the financial impact on the audit;

• Unit price tests on inventory items were limited to checking the latest supplier invoices without

considering whether the costing method was properly applied. Audit teams need to understand the

costing method, e.g. first-in-first-out or weighted average, adopted by clients and design appropriate

audit procedures to test whether costs of inventories are properly determined;


• No follow up procedures for inventory items without subsequent sales (e.g. to understand the reasons

and check last/ subsequent actual selling prices) to ensure inventories are not stated at above their net

realizable value;

• Insufficient or no audit procedures to assess the appropriateness of or need for an inventory provision

were noted. Audit teams should 1) understand clients’ policies for determining inventory provision; 2)

evaluate whether the policies are appropriate and reasonable; 3) review clients’ calculations; 4) obtain

evidence to verify whether the information used by clients in their calculations is appropriate and

reasonable; and 5) review the aging analysis of inventory and the condition of inventories during the

physical stock counts; and

• No consideration of the financial impact of not absorbing costs of conversion (e.g. direct labor and

production overheads) into work-in-progress and finished goods was noted. Audit teams should request

clients to quantify the effect and perform audit procedures to ensure client’s quantification is reasonable.

If the effect is material, audit teams should request their clients to make appropriate adjustments to their


Practices might recognize that some of the shortcomings set out above also exist in their approach to the

audit of inventories. Practices are strongly advised to take appropriate actions to address the shortcomings

relevant to them.

Impairment assessment

We continued to have concerns about the quality of audit evidence on audit files to support auditor’s

judgement on areas such as impairment of goodwill and other assets. In general, we considered that the

level of challenge by audit teams to key assumptions adopted by clients was not rigorous enough to support

their conclusions on whether impairment was adequately made or not required. The following are some

examples:

• Projected growth rates set by client appeared unrealistically high compared to client’s historical

performance but there was no evidence that they were critically questioned by the audit team;

• Discount rate applied by client appeared unreasonably low but the audit team did not critically evaluate

whether the rate reflected current market conditions as well as the risks specific to the client’s asset;

• Amounts due to related companies, employees and directors were included in the carrying amount

of the cash generating unit used to compare with its value in use but the audit teams did not evaluate

whether these liabilities were of a trade nature such that it would be appropriate to include them in the

carrying amount for assessment; and

• Goodwill was wrongly allocated to cash generating units which were larger than an operating segment

but the audit teams did not evaluate the impact of non-compliance with HKAS 36.


Practices often explained that they tried their best and used all information available to audit asset

impairment within the tight reporting timeframe. When practices believe that they are not able to carry out

a proper impairment assessment of those assets before the reporting timeframe, they should liaise with their

client, carry out the test earlier in the year and only update the test at the year-end if there is an indication

that the assets might be impaired.

In general, practices should heighten the level of professional skepticism when assessing evidence on an

asset impairment assessment that involves significant estimation or judgment by the client. Persuasive audit

evidence should be obtained on these areas. Practices should ensure there is sufficient audit evidence on file

to reduce the risk of being challenged by external reviewers or regulators in relation to their audit procedures

performed or conclusions reached.

Highest and best use measurement

HKFRS 13 Fair Value Measurement includes new concepts and guidance on how fair value is measured for

financial reporting purposes and “highest and best use” is one of those concepts. The Standard requires

fair value be determined by reference to the highest and best use of a non financial asset such as land and

property.

In determining the highest and best use, an entity should consider whether the use of the asset is physically

possible (e.g. location or size of the site), legally permissible (e.g. zoning regulations applicable to the site)

and financially feasible (e.g. producing a net positive return after taking into account the costs of converting

the asset to that use) as required by HKFRS 13. The highest and best use is determined from the perspective

of market participants, even if the entity intends a different use.

The Standard also requires the reporting entity to presume that the current use of the asset is its highest

and best use unless market or other factors suggest that a different use by market participants would

maximize the value of the asset. Instances were noted where such factors existed e.g. a change in land

use for redevelopment purposes had been granted by relevant government authorities. In some of

those cases, the entities continued to use the current use as the highest and best use of the relevant

assets but the practices did not follow up to assess whether proper consideration had been given to all

relevant information before concurring with the treatment. Practices are also reminded to document

their assessment to support why the current use represented the highest and best use if there had been

indications or evidence showing otherwise.


Audit evidence

The primary objective of an audit is to enable the auditor to obtain sufficient appropriate audit evidence

in order to draw reasonable conclusions on the matters on which the auditor is to report. Practice review

findings often raise questions about the sufficiency and appropriateness of audit evidence.

In carrying out audit tests many smaller practices still relied solely on documents generated by the client

without giving due consideration to their reliability. For example, practices only checked internally generated

sales invoices or service billings in carrying out transaction and cut-off tests. Clients’ accounting policies for

revenue should be reviewed to determine when revenue should be recognized and, based on the assessment

and understanding of the clients’ financial reporting system, documents with third party evidence to support

the recognition of revenue, e.g. goods delivery documents with acknowledgement of goods received by

customers, should be inspected.

We also found that some practices were not sufficiently involved in the work of component auditors and

some did not even communicate with component auditors when they carried out group audits. Common

issues identified are:

• Inability to participate adequately in the work of component auditors, such as their risk assessment

process to identify significant risks of material misstatements relevant to the group financial statements;

• No documentation to justify the scoping of work and materiality established for components;

• No assessment of (1) competence and qualification of the component auditor; (2) the audit methodology

adopted by the component auditor; and (3) the appropriateness and sufficiency of work performed by

the component auditor; and

• No assessment of whether the financial information of overseas components prepared under local

accounting standards conformed with the accounting standards used for group reporting.

HKSA 600 Special Considerations – Audits of Group Financial Statements (Including the Work of Component

Auditors) makes it clear that the group audit partner/director is responsible for the direction, supervision

and performance of the group audit and ensuring that sufficient appropriate audit evidence is obtained. If

sufficient appropriate audit evidence cannot be obtained on the components, the group auditor should

modify the group audit opinion.


Shortcomings were also identified in engagements that involved work of experts. We still found that some

practitioners merely obtained a copy of the valuation report as audit evidence without performing any

evaluation work as required by HKSA 620 Use the work of an Expert. We also still encountered cases where

there was insufficient work to challenge the assumptions used by experts. In one review, a client appointed

a valuer to determine the fair value of an investment property located in Mainland China. As there was no

recent market transaction of a similar property available, the valuer determined the market value of the

investment property based on the average offering price of comparable properties with some discount.

However, the audit team did not challenge the reliability of the offering prices of comparable properties, and

the reasonableness of the discount applied.

The usual explanation we heard from practitioners was that the expert had more solid experience in carrying

out valuations in relevant industries so they did not feel able to challenge the professional competence of the

expert. In some cases, practitioners argued that they did not possess the same expertise and knowledge so

that they were unable to challenge the expert’s assumptions and methods used.

Practices are reminded that, when the engagement involves the use of work of the client’s expert, the auditor

has the responsibility to evaluate whether the professional valuation is reliable for audit purposes. HKSA 500

Audit Evidence contains guidance on work to be done when using the work of the client’s expert as audit

evidence.

Expectation

Practices are facing new challenges every year,

e.g. new financial reporting standards on leases

and revenue from contracts with customers.

Practitioners and their audit staff should keep

themselves abreast of developments in professional

standards and to ensure that their quality control

and audit policies and procedures remain adequate

to maintain the quality of audit work. Practices

might find that some of the deficiencies set out in

this report also exist in their own quality control systems and / or audit methodology. Practices are advised to

take appropriate action to remediate the deficiencies relevant to them promptly.


33

Our findings

Professional standards monitoring programme

Under our professional standards monitoring programme,

we carry out regular reviews of the financial statements

of Hong Kong listed companies to assess their compliance

with professional standards, particularly on the

application of financial reporting standards. We highlight

below those more significant or common findings that

were identified from our review in 2017. Some of those

findings are issues which have been repeatedly found in

our past reviews. Therefore we advise members to pay particular attention to those issues and make efforts

to avoid them from recurring in future financial statements.

During the periods of financial statements under our reviews in 2017, only one new HKFRS, HKFRS 14

Regulatory Deferral Accounts, and some amendments to the existing HKFRSs had come into effect. These

HKFRS and amendments did not have a material effect on the financial statements reviewed. In Section I of

this report, we provide you with detailed discussions of the significant or common issues identified in the

application of HKFRSs. The HKFRSs covered this year are HKAS 33 Earnings Per Share, HKFRS 10 Consolidated

Financial Statements, HKFRS 11 Joint Arrangements and HKAS 7 Statement of Cash Flows. In addition to

financial reporting issues, we identified some issues relating to the application of the new auditing standard

HKSA 701 Communicating Key Audit Matters in the Independent Auditor’s Report. Since this year is the year

of launch of the long form audit reports for listed entities, we consider it worthwhile to also share the issues

identified with members in this report.

In our 2017 reviews, recurring issues concerning the application of HKFRS 3 (Revised) Business Combinations

and HKAS 36 Impairment of Assets continued to be identified. Those issues have already been discussed in

depth in our previous reports and therefore detailed discussions of those issues are not repeated this year.

The key issues are, however, summarized in Section II as a reminder for members to pay attention in their

audit/preparation of financial statements.

In Section III, we will give you an overview of common disclosure deficiencies identified from our 2017

reviews.

Hong Kong Institute of CPAsQuality Assurance Report 2017

34

Section I – Significant or common findings on HKSAs and HKFRSs

1. HKSA 701 Communicating Key Audit Matters in the Independent Auditor’s Report

HKSA 701, which is a new auditing standard effective from December 2016, requires auditors of listed

entities to describe in their audit reports the key audit matters (“KAMs”) that they have identified and

how they responded to them during their audit. The purpose of communicating KAMs is to enhance the

communicative value of the auditor’s report by providing greater transparency about the audit that was

performed and assist intended users of the financial statements (“intended users”) in understanding

those matters, that in the auditor’s professional judgement, were of most significance in the audit.

Communicating KAMs may also assist intended users in understanding the entity and areas of significant

management judgement.

HKSA 701 deals with key matters identified during the audit, including but not limited to, the issues

identified by auditors in relation to their clients’ application of HKFRSs. HKSA 701 paragraph A30

recognizes that determining which, and how many, of those matters that required significant auditor

attention were of most significance in the audit of the financial statements is a matter of professional

judgement. However, from reviews of KAMs disclosed in the auditor’s reports and the information

provided in the financial statements, questions may arise as to whether the auditors properly identified

KAMs and based on the descriptions of KAMs, whether the auditors applied the relevant HKFRSs

appropriately.

The following are some examples:

(i) A reporting entity had significant goodwill at the year end that arose from the acquisitions of two

subsidiaries including one which was acquired during the year. The KAMs in the auditor’s report only

described the impairment assessment of the goodwill arising from the acquisition of the subsidiary

that took place in the previous year even though the goodwill arising from the current year acquisition

of another subsidiary was much more significant and that subsidiary was in a net liability position and

had been incurring losses for the past few years.

(ii) Another reporting entity reported that its goodwill at the year end related to two cash-generating

units (“CGUs”), CGU A and CGU B. The goodwill allocated to CGU A was brought forward from last

year and was fully impaired in the current year. CGU B consisted of a group of subsidiaries which were

acquired in the current year and no impairment was determined to be necessary after assessment.

The KAM in the auditor’s report however only covered the impairment assessment of the goodwill

arising from CGU B but not CGU A even though (1) CGU A’s goodwill was fully impaired during the

year; (2) the amount of impairment loss recognized was significant to the financial statements; and (3)

the relevant operating segment reported an increase in profit during the year.

(iii) The financial statements of another reporting entity showed that its current year’s revenue increased

by more than 5 times of the previous year. The entity was engaged in a project construction business

and recognized revenue based on contracts signed with customers and there had been no changes

in the entity’s business operating model in the current year of reporting. Accounting for construction


35

contracts is usually an area that requires significant professional judgement. The substantial increase

in revenue raised further questions as to why revenue recognition was not identified as a KAM by the

auditor.

HKSA 701 paragraph 9 requires that, in determining KAMs, auditors shall take into account areas of

higher assessed risk of material misstatements; significant auditor judgements relating to areas in the

financial statements that involved significant management judgement; and the effect on the audit of

significant events or transactions. HKSA 701 paragraph 10 further requires auditors to determine which

matters are of most significance in the audit of financial statements so as to report them as KAMs in

the auditor’s report. In the above examples, it was unclear why the auditors did not report the above

matters (i.e. goodwill of the new subsidiary in Example (i), the fully impaired goodwill of the subsidiary in

Example (ii) and revenue recognition in Example (iii)) as KAMs under the requirements of HKSA 701; and

that they had properly addressed the risk of material misstatements arising from those particular areas by

designing and performing sufficient appropriate audit procedures to make sure that the related items (i.e.

goodwill and revenue as discussed) were fairly stated in the financial statements.

Members, especially auditors, should be conscious that the matters disclosed as KAMs in the auditor’s

report should be matters that have been previously communicated with those charged with governance

and management of the reporting entities. Where we consider an enquiry is warranted, auditors may

also be asked to provide information about their communication with those charged with corporate

governance and management of the reporting entities.

Apart from the above three examples, in our 2017 reviews, we also identified the following deficiencies

in the application of HKSA 701:

(i) The description of KAMs in the auditor’s report did not include a reference to the related disclosures

in the financial statements as required by HKSA 701 paragraphs 13 and A40.

(ii) The auditor inappropriately reported the material uncertainties about the entity’s ability to operate

as a going concern as one of the KAMs in its auditor’s report. This does not comply with HKSA 701

paragraph 15 which states that although such matters are by nature one of the KAMs, they shall not be

described in the KAM section in the auditor’s report. Instead, the auditor shall report on the matter in

accordance with HKSA 570 (Revised) Going Concern and include a reference to the “Basis for Qualified

(Adverse) Opinion” or the “Material Uncertainty Related to Going Concern” sections(s) in the KAMs

section.

It is also worth noting that, when the auditor concludes in accordance with HKSA 570 (Revised) that

no material uncertainty exists relating to events or conditions that may cast significant doubt on

the entity’s ability to continue as a going concern, it may nevertheless determine that one or more

matters relating to this conclusion arising from its work effort under HKSA 570 (Revised) are KAMs.

In such circumstances, the auditor’s description of such KAMs in the auditor’s report could include

aspects of the identified events or conditions disclosed in the financial statements, such as substantial

operating losses, available borrowing facilities and possible debt refinancing, or non-compliance with

loan agreements, and related mitigating factors (HKSA 701 paragraph A41).


36

First year review of revised auditor’s reports

The Institute’s Standard Setting Department published in October 2017 a research report on the first

year experience of the revised auditor’s’ report. The research observed how auditors implemented

HKSA 701 based on a review of audit reports issued on Hong Kong listed entities. The research report

shows that the number of KAMs reported by entities listed on the Main Board ranged from 1 to 8

KAMs. It reported that impairment of receivables, property valuation, goodwill, impairment of non-

financial assets and revenue recognition are the top 5 KAMs reported. These areas are common

risk areas that require significant professional judgement in their accounting and therefore demand

significant auditor attention and focus.

The full research report can be downloaded from the link below: http://www.hkicpa.org.hk/file/

media/section6_standards/standards/Audit-n-assurance/kamrp1017.pdf

2. HKAS 33 Earnings per Share

Earnings per share (“EPS”) is a ratio calculated by dividing the earnings measured in terms of profits

available to ordinary shareholders (the numerator) by the weighted average number of ordinary

shares outstanding during the period (the denominator). Although the concept of EPS might be

easy to understand, the calculation might sometimes not be so straightforward in particular on the

determination of the denominator.

a. Issuance of shares under an open offer

It is not uncommon for a Hong Kong listed entity to raise additional capital through a rights issue or

an open offer. We occasionally found some reporting entities not to have properly considered the

implication of an open offer for EPS. We would like to remind members that, if an open offer contains

a bonus element and the ordinary shares are to be issued to all existing shareholders on a pro-rata

basis, such open offer, by its nature, could be similar to a rights issue and when it is so confirmed the

calculation guidelines on a rights issue under HKAS 33 (i.e. HKAS 33 paragraph A2) would apply and

the basic and diluted EPS for all periods presented would be adjusted retrospectively as required by

HKAS 33 paragraphs 26 and 27. However, all relevant facts and circumstances (e.g. see the second

example below) shall be considered before arriving at the conclusion on whether or not the open

offer contains a bonus element.

HKAS 33 paragraph 26 states that “The weighted average number of ordinary shares outstanding

during the period and for all periods presented shall be adjusted for events, other than the conversion

of potential ordinary shares, that have changed the number of ordinary shares outstanding without a

corresponding change in resources” (underline added).

HKAS 33 paragraph 27 states that “Ordinary shares may be issued, or the number of ordinary shares

outstanding may be reduced, without a corresponding change in resources. Examples include: .….

(b) a bonus element in any other issue, for example a bonus element in a rights issue to existing

shareholders” (underline added).


http://www.hkicpa.org.hk/file/media/section6_standards/standards/Audit-n-assurance/kamrp1017.pdf

http://www.hkicpa.org.hk/file/media/section6_standards/standards/Audit-n-assurance/kamrp1017.pdf

37

A reporting entity issued ordinary shares through an open offer. The prospectus of the open offer

mentioned that the open offer would be available to all existing shareholders on the basis of one offer

share for certain existing shares held (i.e. a pro-rata basis) and that the subscription price represented

a discount to the theoretical ex-entitlement price based on the closing price of the share as quoted on

the Stock Exchange on the last trading day. In the financial statements, the reporting entity disclosed

that the effect of the open offer was taken into account in the weighted average number of ordinary

shares outstanding in calculating the EPS for the current year. That means no restatement was made

to prior periods.

As stated, the matter in question is whether the above open offer contained a bonus element. If that

was the case, the entity should have referred to the guidelines (HKAS 33 paragraph A2) on a rights

issue to calculate the EPS since shares were issued to all existing shareholders on a pro-rata basis. In

particular, HKAS 33 requires retrospective adjustments to the denominator for all periods before the

rights issue. The bonus element inherent in a rights issue is measured by a prescribed formula set out

in HKAS 33 paragraph A2. The number of ordinary shares to be used in calculating basic and diluted

EPS for all periods before the rights issue is the number of ordinary shares outstanding before the

issue, multiplied by the following factor:

Fair value per share immediately before the exercise of rights

Theoretical ex-rights fair value per share1

A discounted price being offered to all existing shares suggested that there could be a bonus element

in the open offer. If, after a thorough assessment of all relevant facts and circumstances including the

terms and conditions of the open offer, it was concluded that there was a bonus element, the entity’s

EPS for all periods presented should be adjusted for the effect of the open offer according to HKAS

33 paragraphs 26 and 27.

In another set of the financial statements reviewed, the reporting entity launched an open offer as

part of an acquisition transaction to acquire the entire equity interest of a company. The transaction

constituted a reverse acquisition. The legal acquirer, i.e. the reporting entity, was treated as the

accounting acquiree whereas the legal acquiree, the company being acquired, was treated as the

accounting acquirer. The subscription price was offered at a discounted value to the last published

share price of the reporting entity (before suspension of share trading) and shares were to be issued

to all existing shareholders on a pro-rata basis. However, in this case, the shares of the reporting

entity had been suspended for more than five years. Management was therefore of the view that the

last published share price of the reporting entity, which was already more than five years ago, did not

represent the fair value of the shares when the open offer was launched. Instead, it considered that

the open offer share price represented the fair value of the reporting entity’s shares and therefore no

bonus element was involved in the open offer. Nevertheless, we would expect the auditor to have

obtained sufficient appropriate evidence before it concurred with the management’s view that the

open offer share price represented the fair value of the shares of the reporting entity.

1 The theoretical ex-rights fair value per share is calculated by adding the aggregate fair value of the shares immediately before

the exercise of the rights to the proceeds from the exercise of the rights, and dividing by the number of shares outstanding

after the exercise of the rights.


38

The above two examples illustrate that, in determining whether or not an open offer contains a

bonus element, detailed and careful assessment should be performed on a case-by-case basis after

taking into account all relevant facts and circumstances.

b. Convertible preference shares

A reporting entity disclosed in its financial statements that its “Issued share capital” consisted of

“Ordinary shares, issued and fully paid” and “Convertible preference shares, issued and fully paid”. In

calculating the basic and diluted EPS, the reporting entity included the convertible preference shares

when determining the weighted average number of ordinary shares outstanding (the denominator).

The question is whether and how the convertible preference shares would have impacted the EPS

calculation under the above entity’s circumstances. In particular, whether it was appropriate to

include the convertible preference shares in the basic EPS calculation, or should they only be included

in the diluted EPS calculation when the convertible preference shares were in fact potential ordinary

shares under HKAS 33 paragraph 7(a).

A key point to consider is whether the convertible preference shares have a “participating feature”

such that they constitute “ordinary shares” under HKAS 33. The holder of preference shares may be

given a right to participate in the profit with ordinary shares according to a pre-determined formula,

but with an upper limit or cap on the extent of participation by the preference shares (HKAS 33

paragraph A13(a)). For example, the preference shares may entitle its holder to receive a fixed rate of

dividend (e.g. HK$2.1 per share) and participate in any additional dividends declared (e.g. on a 20:80

ratio with ordinary shares) up to a maximum of a specified amount. HKAS 33 describes this kind of

preference shares as “participating equity instruments”.

Sometimes an entity may also have a class of ordinary shares with a different dividend rate from that

of another class of ordinary shares but without prior or senior rights. They are described as “two-class

ordinary shares” (HKAS 33 paragraph A13(b)).

As required by HKAS 33, if an entity has participating preference shares and/or two-class ordinary

shares, for the purposes of calculating basic and diluted EPS, it shall follow the steps set out in

HKAS 33 paragraph A14 to allocate the earnings (the numerator) to different classes of shares and

participating equity instruments in accordance with their dividend rights or other rights to participate

in undistributed earnings. In situations where the participating preference shares are convertible into

ordinary shares, conversion is assumed if the effect is dilutive and accordingly, the conversion shares

will be included in the number of outstanding ordinary shares (the denominator) for the purpose of

calculating diluted EPS.


39

HKAS 33 paragraph 66 requires entities having more than one class of ordinary shares to calculate

and present the EPS for each of the classes. HKAS 33 paragraphs A13 and A14 also require EPS to

be disclosed for each of different classes of ordinary shares and participating equity instruments.

Members may refer to Example 11 appending to HKAS 33 which provides a worked example of how

basic and diluted EPS should be calculated and presented based on distributed and undistributed

earnings allocated to participating equity instruments and two-class ordinary shares.

Back to the above example, the financial statements of the reporting entity disclosed that (i)

the holder of the convertible preference shares is entitled to receive the same rate of dividends /

distributions as the holders of ordinary shares; and (ii) the holder of the convertible preference shares

ranks pari passu with other holders of the ordinary shares in respect of its entitlement to dividend or

other distribution. Such disclosures suggested that the convertible preference shares are “participating

equity instruments” and therefore it appears to be appropriate to include the convertible preference

shares in the basic EPS calculation. It should be noted that HKAS 33 requires entities to separately

present basic and diluted EPS based on distributed and undistributed earnings allocated to each class

of ordinary shares and convertible preference shares if they have different rights to share in the profit

for the period.

The above example also reveals the essence of a careful review of the terms and conditions of the

preference shares in order to identify features which may have an implication for the EPS calculation.

Accordingly, it would not be appropriate to simply jump into a conclusion that convertible preference

shares may only affect the diluted EPS calculation as they may have participating features that affect

the basic EPS calculation.

c. Share consolidation

A set of financial statements disclosed that the weighted average number of ordinary shares in issue

during the year used in the basic earnings per share was about four times the number of ordinary

shares outstanding at the year end. The above information appears not to be reasonable. It was

noted that during the year there was a share consolidation in which five shares were consolidated

into one share.

HKAS 33 paragraph 26 states that “The weighted average number of ordinary shares outstanding

during the period and for all periods presented shall be adjusted for events, other than the conversion

of potential ordinary shares, that have changed the number of ordinary shares outstanding without a

corresponding change in resources” (underline added). HKAS 33 paragraph 28 also states that “The

number of ordinary shares outstanding before the event is adjusted for the proportionate change

in the number of ordinary shares outstanding as if the event had occurred at the beginning of the

earliest period presented” (underline added).


40

In the above example, as the weighted average number of ordinary shares was much more than

the ordinary shares outstanding, this suggested that the reporting entity did not follow the above

requirements of HKAS 33 to adjust for the effect of share consolidation as if the share consolidation

had occurred at the beginning of the earliest period presented. In response to our enquiry, the auditor

admitted that there was a calculation error in determining the weighted average number of ordinary

shares and that the share consolidation had not been adjusted for the proportionate change in the

number of ordinary shares outstanding as if the share consolidation had occurred at the beginning

of the earliest period presented. We noted that the reporting entity subsequently published an

announcement to show that corrections had been made to both basic and diluted EPS because of the

share consolidation.

d. Other disclosure deficiencies

Apart from the above issues identified regarding the calculation of basic and diluted EPS, we also

noted the following disclosure deficiencies in respect of application of HKAS 33:

(i) A reporting entity presented diluted loss per share in prior year but disclosed “N/A” for the

current year. This does not comply with HKAS 33 paragraph 67 which requires diluted EPS to be

reported for all periods presented even if it equals basic EPS.

(ii) A reporting entity omitted to present basic and diluted earnings per share for profit from

continuing operations in the statement of comprehensive income as required by HKAS 33

paragraph 66.

e. Other references

The Compliance Department of the Institute published an article in A-Plus about real cases of EPS

errors encountered in handling complaints and the root causes of those errors. The article covers

areas relating to share split/share subdivision, share capitalization, share consolidation and rights

issue. Members are advised to read this article to understand more about how HKAS 33 should be

applied in practice. The article is available from the link below:

https://aplusmag.goodbarber.com/previous-issues/c/2/i/17334285/technical-update


https://aplusmag.goodbarber.com/previous-issues/c/2/i/17334285/technical-update

41

3. HKFRS 10 Consolidated Financial Statements, HKFRS 11 Joint Arrangements and HKFRS 3 (Revised)

Business Combinations

In determining an appropriate accounting treatment for a transaction, or a series of transactions, there

might be times where multiple financial reporting standards need to be considered. Therefore, members

need to be conversant with the requirements of all relevant HKFRSs. The following case involving a series

of acquisition and disposal transactions is a common example of the application of HKFRS 3 (Revised), 10

and 11.

A reporting entity held respectively 65%, 51% and 95% equity interests in three investees which were

accounted for as joint ventures in its consolidated financial statements. During the year (i.e. 2016), the

reporting entity entered into some equity transfer agreements to acquire the remaining equity interests in

the three investees from independent counter-parties. After the acquisitions, the three investees became

wholly-owned subsidiaries of the reporting entity. Upon the acquisition transactions, the reporting entity

recognized a significant gain in its consolidated profit or loss from remeasuring its originally held equity

interests in the three investees.

In respect of the three investees mentioned above, we noted that they were previously wholly-owned

subsidiaries of the reporting entity and some equity interests in those subsidiaries were partially disposed

of by the reporting entity in 2014. Following the partial disposals in 2014 and before reacquiring their

interests in 2016, the investees were accounted for as joint ventures of the reporting entity. In accounting

for the partial disposals, the reporting entity measured and recognized its remaining interests (i.e. 65%,

51% and 95% as referred to in the above) in the three investees at fair value, and as a result, significant

gains arising from disposal and remeasurement of the remaining interests in the investees (“disposal and

remeasurement gains”) were recognized in the 2014 consolidated financial statements. It was further

noted that the reporting entity had provided significant guarantees to the counter parties for their loans

granted to the investees.

a. Compliance with HKFRS 10 and HKFRS 11

In view that the reporting entity (i) retained significant interests (65%, 51% and 95% i.e. all over

50%) in the three investees after the partial disposals and (ii) provided guarantees to the counter

parties for their loans granted to the investees, concerns were raised as to whether the reporting

entity indeed had lost control over the investees in 2014 such that it was appropriate to account for

the investees as joint ventures and recognize disposal and remeasurement gains from the retained

interests in 2014 upon the partial disposals and to recognize another remeasurement gain upon

reacquiring the interests in the same investees subsequently in 2016. Enquiries were therefore

raised with the auditor to obtain more information about the arrangements and the audit evidence

obtained to support the accounting treatments.


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Loss of control

In determining whether an entity has control over an investee, it shall look into the requirements of

HKFRS 10. In particular, HKFRS 10 paragraph 7 states that “an investor controls an investee if and

only if the investor has all the following: (a) power over the investee (see paragraphs 10–14); (b)

exposure, or rights, to variable returns from its involvement with the investee (see paragraphs 15 and

16); and (c) the ability to use its power over the investee to affect the amount of the investor’s returns

(see paragraphs 17 and 18)” (underline added). In other words, if any of the above three conditions is

not met, the investor is not considered to have control over the investee.

HKFRS 11 paragraph 4 states that “A joint arrangement is an arrangement of which two or

more parties have joint control”. HKFRS 11 paragraph 7 further states that “Joint control is the

contractually agreed sharing of control of an arrangement, which exists only when decisions about

the relevant activities require the unanimous consent of the parties sharing control” (underline

added).

In response to our enquiry, the auditor provided more details regarding the above transactions to

support the management’s view that the reporting entity had lost control upon the partial disposals

of the three investees in 2014 but from then gained joint control over them.

The auditor advised that based on the legal documents they had reviewed during the audit (e.g. the

relevant investment agreements entered into between the reporting entity and the counter-parties

and the articles of association of the three investees), before the re-acquisition transactions, the

board of directors of each of the three investees consisted of 5 to 6 directors and that the reporting

entity was entitled to appoint 3 to 5 directors to each of them. However, the relevant activities of

the investees required unanimous approval at the board of directors. Therefore the counter parties’

seats on the boards of directors of the investees gave them rights to prevent decisions over relevant

activities being approved and directed by the directors appointed by the reporting entity. Based on

the above fact patterns, it appears that upon the partial disposals of the equity interests in the three

investees, the reporting entity only shared joint control with the counter parties. As described in

HKFRS 11 paragraph 8, under a joint arrangement, all the parties, or a group of the parties, control

the arrangement collectively and they must act together to direct the activities that significantly affect

the returns of the arrangement (i.e. the relevant activities).

Members are advised that a thorough assessment of all relevant facts and circumstances, including

obtaining an understanding of the reasons for the disposals, evaluating the purpose and design of

the investees, the activities of the investees and how decisions of those activities are made and the

rights held by each of the investor, is required for determining whether control exists or not and the

subsequent accounting treatment of the investees after the disposals (in this case all three investees

were accounted for as joint ventures). Significant judgement may be needed in some cases. There


43

might be also cases where it may be difficult to determine whether an investor’s rights are sufficient

to give it power over an investee and vice versa. In such cases, to enable an assessment of power to be

made, the investor shall consider evidence of whether it has the practical ability to direct the relevant

activities unilaterally (HKFRS 10 paragraph B18). Consideration should be given to the guidelines

under HKFRS 10 paragraph B18 and the indicators in HKFRS 10 paragraphs B19 and B20 in assessing

whether the investor’s rights are sufficient to give it power over the investee. Auditors should critically

challenge the appropriateness of their clients’ accounting treatment based on detailed assessment of

the audit evidence obtained in addition to the legal documents provided by the clients.

Calculation of disposal and remeasurement gains

HKFRS 10 paragraphs 25 and B97 to B99 set out the requirements for the accounting for the loss

of control. Under the requirement, the parent shall (i) derecognize the assets and liabilities of the

former subsidiary from its consolidated statement of financial position; (ii) recognize any investment

retained in the former subsidiary at its fair value when control is lost and (iii) recognize the gain or loss

associated with the loss of control attributable to the former controlling interest.

In the above example, the reporting entity measured its retained interests in the investees in 2014

and calculated the disposal and remeasurement gains by following the above guidelines under

HKFRS 10. In this regard, the auditor was expected to have reviewed the reporting entity’s calculation

and perform adequate work to assess whether the reporting entity’s fair value measurement of its

retained interests in the investees was appropriate and in accordance with the requirements of HKFRS

13 Fair Value Measurement.

We have discussed other issues identified in relation to application of HKFRS 10, HKFRS 11 and HKFRS

12 Disclosure of Interests in Other Entities in our 2014 QAD annual report. Some of those issues were

still identified in our 2016 reviews (e.g. lack of disclosures to support why the reporting entity had

control over the other entity even though it had less than 50% interest in that entity). Members may

refer to the following link for more details:

http://www.hkicpa.org.hk/file/media/section6_standards/quality_assurance/2014/qa-report2014.pdf

b. Compliance with HKFRS 3 (Revised)

It is common for an entity to have previously held an equity interest in an investee before gaining

control over it. Such kind of transaction is sometimes referred to as a “step acquisition” and its

accounting treatment is addressed in HKFRS 3 (Revised) paragraphs 41 and 42. In a step acquisition,

the acquirer shall remeasure any previously held equity interest in the acquiree immediately at

its acquisition-date fair value and recognize any resulting fair value gain or loss in profit or loss

(“remeasurement gain”).


http://www.hkicpa.org.hk/file/media/section6_standards/quality_assurance/2014/qa-report2014.pdf

44

In the above example, the reporting entity engaged independent valuers to conduct valuations of

the identifiable assets and liabilities of the investees at the dates of reacquiring control. Based on

the independent valuations, the reporting entity recognized significant remeasurement gains that

were attributable to the percentage of the reporting entity’s previously held interests in the investees.

Auditors were expected to have gained an adequate understanding of the basis for the valuations

and challenged the fair value measurement including the assumptions used by the client (e.g.

whether the increase in fair value of the assets of the investees was justifiable) before arriving at the

audit conclusion that the remeasurement gains recognized by the client were appropriate. Critical

judgement and estimates used in the fair value measurement should be disclosed in the financial

statements.

4. HKAS 7 Statement of Cash Flows

HKAS 7 requires all entities to prepare a statement of cash flows in accordance with the requirements of

HKAS 7 and present it as an integral part of its financial statements for each period for which financial

statements are presented (HKAS 7 paragraph 1). There are no exemptions provided under HKAS 7 from

the preparation of such statement. Cash flow information is useful for users of the financial statements

(e.g. existing and potential investors, lenders and other creditors) to assess the ability of the entity to

generate cash and cash equivalents and to utilize those cash flows (HKAS 7 objective paragraph).

HKAS 7 also enhances the comparability of the reporting of operating performance of different entities

because it eliminates the effects of using different accounting treatments for the same transactions and

events (HKAS 7 paragraph 4).

In previous years’ QAD annual reports, presentation and disclosure deficiencies in respect of the

application of HKAS 7 were generally summarized in the disclosure deficiency section. In this year, we

have chosen a few more significant and/or common deficiencies for discussions in this section in the

hope to draw more members’ attention.

a. Non-cash transactions

A cash flow statement should report only transactions that involve a cash inflow or outflow. In other

words, transactions that do not involve a cash flow shall not be reported in the statement of cash

flows. Under HKAS 7 paragraph 43, investing and financing transactions that do not require the use

of cash or cash equivalents must be excluded from the statement of cash flows. Such transactions

shall be disclosed elsewhere in the financial statements in a way that provides all the relevant

information about these investing and financing activities. However, we occasionally found that some

entities did not comply with the above requirement.

A reporting entity disclosed in its note to the financial statements that during the year, it acquired

property, plant and equipment at a total cost of HK$23 million. However, the amount of “purchase of


45

property, plant and equipment” shown in the consolidated statement of cash flows was only HK$9

million. This suggested that some of the property, plant and equipment acquired were not purchased

by cash. From the Management Discussions and Analysis (“MD&A”) section of the reporting entity’s

annual report, it was noted that some machineries were purchased through finance leases.

The above example appears to involve some non-cash financing transactions, which should have

been disclosed elsewhere in the financial statements (i.e. note disclosures). However, no such

disclosure was found in the financial statements. Members should be aware that MD&A section

of the annual report is not part of the financial statements. Therefore having covered the required

information in the MD&A section does not mean that it is not required to be disclosed again in the


HKAS 7 paragraph 44 provides examples of non-cash investing and financing activities, which do not

have a direct impact on current cash flows although they do affect the capital and asset structure of

an entity. Those examples include the acquisition of assets by assuming directly related liabilities, the

acquisition of an entity by means of an equity issue and the conversion of debt to equity.

b. Classification of cash flows – operating, investing or financing

Cash flows reported in a statement of cash flows are classified by activities, i.e. operating, investing

and financing activities. As defined in HKAS 7 paragraph 6, investing activities are the acquisition

and disposal of long-term assets and investments that are not cash equivalents. Financing activities

are activities that result in changes in equity capital and borrowings of the entity. Operating activities

are the principal revenue-producing activities of the entity and all activities that are not investing or

financing.

Entities shall, based on the management’s judgement and the requirements of HKAS 7, classify

and report its cash flows from operating, investing and financing activities in a manner that is most

appropriate to its business. For example, a non-financial entity may classify interest paid as operating

or financing activities and dividend received and interest received as operating or investing activities

(HKAS 7 paragraphs 33 and 34). However, in some occasions, it was unclear as to how management

determined the classification of cash flows. The following are some issues encountered during our

reviews in relation to classification of cash flows:

(i) A reporting entity classified the cash flows arising from “temporary funding activities” as

operating activities. In relation to the entity’s “temporary funding activities”, notes to the

financial statements provided the following information: (1) the reporting entity had significant

temporary funding receivables from non-related parties; (2) it had significant amount due from

a joint venture as a result of entrusted loans granted to the joint venture; (3) it had a significant

amount due to related parties which represented temporary funding borrowed from those

related parties; and (4) its principal activities were development and investment in real estate

projects (i.e. not a financial institution engaging in money lending activities).


46

As the above “temporary funding activities” were not part of the principal activities of the

reporting entity, it might be more appropriate to classify the respective cash flows as investing

(for the receivables from the non-related parties and the entrusted loans granted to the

joint ventures) or financing (for the funds borrowed from related parties) in the consolidated

statement of cash flows.

(ii) A reporting entity classified its cash flows relating to purchases and disposal of trading securities

as investing activities. However, as required by HKAS 7 paragraph 15, the above cash flows

should have been classified as operating activities as the relevant securities were held for trading

purposes, similar to inventories acquired specifically for resale.

c. Reporting cash flows on a gross or net basis

Apart from the two exceptions provided in HKAS 7 paragraphs 22 and 24 (see below), cash flows

shall be reported on a gross basis. Under HKAS 7, cash flows from investing and financing activities

are reported in the same manner, regardless of the method used for reporting the cash flows from

operating activities. Operating cash flows shall be reported by either the direct method (i.e. showing

major classes of gross cash receipts and gross cash payments) or the indirect method (i.e. adjusting

profit or loss to determine the operating cash flows), although entities are encouraged to use the

direct method (HKAS 7 paragraph 19).

A reporting entity presented an item “Net increase in restricted cash relating to financing activities”

under the section of financing activities in its consolidated statement of cash flows. However, HKAS

7 paragraph 21 states that “An entity shall report separately major classes of gross cash receipts and

gross cash payments arising from investing and financing activities, except to the extent that cash

flows described in paragraphs 22 and 24 are reported on a net basis” (underline added).

Since the above item was classified under the financing activities section, the reporting entity should

have followed the requirements of HKAS 7 to present gross cash receipts and gross cash payments of

the restricted cash in its consolidated statement of cash flows, unless those cash flows had met the

limited exceptions provided in HKAS 7 paragraphs 22 and 24.

HKAS 7 paragraph 22 states that “Cash flows arising from the following operating, investing or

financing activities may be reported on a net basis: (a) cash receipts and payments on behalf of

customers when the cash flows reflect the activities of the customer rather than those of the entity;

and (b) cash receipts and payments for items in which the turnover is quick, the amounts are large,

and the maturities are short”.

HKAS 7 paragraph 24 states that “Cash flows arising from each of the following activities of a

financial institution may be reported on a net basis: (a) cash receipts and payments for the acceptance

and repayment of deposits with a fixed maturity date; (b) the placement of deposits with and

withdrawal of deposits from other financial institutions; and (c) cash advances and loans made to

customers and the repayment of those advances and loans”.


47

d. Other voluntary disclosures

As stated in HKAS 7 paragraph 50, additional information may be relevant to users in understanding

the financial position and liquidity of an entity. Disclosing such additional information, together with

a commentary by management is encouraged. For instance, in a case where a reporting entity had

a significant amount of borrowings, disclosure of the amount of undrawn borrowing facilities that

may be available for future use would be useful to users in understanding the liquidity of the entity.

Further examples of additional information can be found in HKAS 7 paragraph 50.

e. Other reference

In December 2010 QAD published an alert concerning the key principles and application issues of

HKAS 7. It is available at:

http://www.hkicpa.org.hk/file/media/section6_standards/technical_resources/pdf-file/

financialauditing/2010/fraa-12.pdf

Section II – Common or significant findings on other HKFRSs

The number of issues identified in relation to the application of HKFRS 3 (Revised) Business Combinations

and HKAS 36 Impairment of Assets continues to rank top in our list for 2017. Many of those issues are

recurring issues and discussed in detail in our prior years’ QAD annual reports. The following is a highlight of

some deficiencies that we came across during the 2017 reviews.

1. HKFRS 3 (Revised) Business Combinations

HKFRS 3 (Revised) applies to a transaction or event that meets the definition of a business combination

(HKFRS 3 (Revised) paragraph 2). A business combination is defined as “A transaction or other event

in which an acquirer obtains control of one or more businesses”. If the transaction is a business

combination, then the acquirer shall follow the requirements of HKFRS 3 (Revised) to account for the

transaction, unless the transaction falls within the exceptions identified in HKFRS 3 (Revised) paragraphs

2 or 2A. Under HKFRS 3 (Revised), all business combinations shall be accounted for by applying the

acquisition method.

Based on the above, the most common issues are:

(i) whether the transaction was appropriately determined as an acquisition of a business as opposed to

an acquisition of assets by reference to the definition of a business under HKFRS 3 (Revised); and

(ii) whether goodwill or a gain from a bargain purchase was appropriately measured and recognized in

accordance with HKFRS 3 (Revised).


http://www.hkicpa.org.hk/file/media/section6_standards/technical_resources/pdf-file/financialauditing/2010/fraa-12.pdf


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In respect of (i), an entity shall start by considering whether the acquisition transaction falls into the

scope of HKFRS 3 (Revised), i.e. whether the transaction is a “business” combination. If not, it shall

apply other applicable HKFRS. In 2017 reviews, we came across instances where it was unclear how the

management justified that the transaction was a business combination and therefore supported that it

was appropriate to account for the transaction under HKFRS 3 (Revised). In one case, the acquired group

had no material assets and liabilities and, save for some minimal incorporation fee, also did not generate

any revenue or profit during the period. In the relevant financial statements, there was no disclosure of

the critical judgement applied by management to justify how the transaction had met the definition of a

business combination under HKFRS 3 (Revised).

On the contrary, there were also cases where it was unclear why the transaction was considered as

an acquisition of assets and liabilities, rather than an acquisition of a business although the acquiree

appeared to have the inputs and processes that were capable of producing outputs. It is worth noting

that, the lack of outputs such as revenue or a product, does not prevent the entity from being considered

as a business (HKFRS (Revised) paragraph B7).

In respect of (ii), the acquirer shall recognize, separately from goodwill, the identifiable assets acquired,

the liabilities assumed and any non-controlling interest in the acquiree (HKFRS 3 (Revised) paragraph 10)

as of the acquisition date. Following on from this requirement, the acquirer may recognize some assets

and liabilities that the acquiree had not previously recognized in its financial statements (HKFRS 3 (Revised)

paragraph 13).

Based on our review experience, the assets that were often overlooked by members for recognition

are intangible assets (e.g. brand name, patents, customer relationships and in-process research and

development costs). This is because those assets might not have been recognized as assets in the

financial statements of the acquiree as they were developed internally and the related costs incurred

were charged to expenses as incurred (HKFRS 3 (Revised) paragraph 13). Examples of identifiable

intangible assets are provided in HKFRS 3 (Revised) paragraphs IE18 to IE44 under five headings,

marketing-related, customer-related, artistic-related, contract-based and technology-based intangible

assets.

In one case, significant goodwill was recognized from an acquisition of a subsidiary which was in a net

liability position at the acquisition date. As there was no disclosure of the factors that contributed the

goodwill, it was questionable why the reporting entity was willing to pay a significant amount to acquire

the acquiree with a net liability position as of the acquisition date, e.g. whether the acquiree in fact had

any intangible assets which qualified for recognition under HKFRS 3 (Revised). Enquiries were therefore

raised with the auditors.


49

On the other hand, a bargain purchase is a business combination in which the net fair value of the

identifiable assets acquired and liabilities assumed exceeds the aggregate of consideration transferred,

the non-controlling interest and the fair value of any previously held interest in the acquiree. Unless

an acquisition is a forced sale transaction as described in HKFRS 3 (Revised) paragraph 35, it might

sometimes be difficult to envisage why the seller of the acquiree is willing to sell its interest in the

acquiree at a discounted price. Some cases reported that the bargain purchase gains recognized were

significant, but there were no disclosures of the circumstances that gave rise to a bargain purchase to

support the recognition.

In response to our enquiries, the auditor explained that the management considered that the reasons

giving rise to a bargain purchase had involved some sensitive information and therefore they were not

willing to disclose them in the financial statements. Therefore proper disclosures should be made as

required by HKFRS 3 (Revised). In this case, the auditor should have considered whether there was any

audit implication with regard to the management’s refusal to disclose the required information under

HKFRS 3 (Revised).

2. HKAS 36 Impairment of Assets

All assets that are within the scope of HKAS 36 require an impairment test when there is an indication of

impairment at the reporting date (HKAS 36 paragraph 9) but certain assets (e.g. goodwill acquired in a

business combination) require an annual impairment test irrespective of whether there is any indication

of impairment (HKAS 36 paragraph 10). The assets that are outside the scope of HKAS 36 are specified

in HKAS 36 paragraph 2, such as financial assets which are within the scope of HKAS 39 Financial

Instruments: Recognition and Measurement. However, it is worth noting that, although investments

in subsidiaries, associates and joint ventures are financial instruments, they are included in the scope of

HKAS 36 unless they are accounted for in accordance with HKAS 39 (HKAS 36 paragraph 4).

The purpose of an impairment test is to ensure that an asset is carried at no more than its recoverable

amount. The recoverable amount of an asset or a cash-generating unit is the higher of its fair value less

cost of disposal and its value in use, reflecting the highest amount expected to be recovered through its

sale or use. When it is not feasible to calculate the recoverable amount of an individual asset, the entity

should measure the recoverable amount of the cash-generating unit to which that asset belongs and

determine the amount of impairment loss to be recognized. (HKAS 36 paragraphs 22 and 66)

Recurring issues relating to the impairment tests performed and relevant disclosures were identified

in the 2017 reviews. In respect of the impairment tests, the issues mainly related to inappropriate

measurement of the recoverable amount arising from the following circumstances:

• Use of an inappropriate measurement basis to determine the recoverable amount (e.g. using the

replacement cost method which was not considered an appropriate method according to HKAS 36

BCZ29);


50

• Use of unreasonable assumptions in the cash flow projections prepared based on the financial

budgets or forecasts approved by management for determining the recoverable amount (e.g.

a higher or increasing level of output was used although the performance of the asset or cash

generating unit is declining);

• Use of a budget or forecast that covered a period longer than five years without a justification

disclosed in the financial statements;

• Inappropriate determination of the cash-generating unit to which goodwill was allocated (e.g. the

determined cash-generating unit was larger than an operating segment determined in accordance

with HKFRS 8 Operating Segments); and

• Use of a post-tax discount rate in the value in use calculation, instead of a pre-tax discount rate as

required by HKAS 36.

Amongst the above, the use of inappropriate assumptions in the impairment testing was the most

commonly found issue. HKAS 36 requires the cash flow projections used to measure value in use to be

based on reasonable and supportable assumptions that represent management’s best estimate of

the economic conditions that will exist over the remaining useful life of the asset (HKAS 36 paragraph

33(a)). We understand that this is challenging and might require significant judgement. In this regard,

HKAS 36 paragraph 34 provides that management should assess the reasonableness of the assumptions

by examining the causes of differences between past cash flow projections and actual cash flows; and

ensure that the assumptions determined are consistent with past actual outcomes.

The commonly omitted disclosures relating to impairment include: the events and circumstances that

led to the recognition or reversal of the impairment loss; the recoverable amount of the assets (or cash-

generating units) and how such amount was determined (fair value less costs of disposal or value in use).

Members are advised to refer to HKAS 36 paragraphs 126 to 136 for details of the relevant disclosure

requirements.

Section III – Common disclosure deficiencies

Save for the disclosure deficiencies as discussed in Section I and Section II of this report, the following is an

overview of the other common disclosure deficiencies identified in our 2017 reviews.

1. HKFRS 7 Financial Instruments: Disclosures

The following disclosures were often missing or incomplete:

• information about (a) the fair value of the collateral held, (b) the fair value of any such collateral sold

or repledged, and whether the entity has an obligation to return it; and (c) the terms and conditions

associated with its use of the collateral when an entity holds collateral (of financial or non-financial

assets) and is permitted to sell or repledge the collateral in the absence of default by the owner of the

collateral (HKFRS 7 paragraph 15);


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• information of each type of risk arising from financial instruments specified under HKFRS 7

paragraphs 33 and 34;

• information about the credit quality of financial assets that are neither past due nor impaired (HKFRS

7 paragraph 36(c));

• a description of the financial instruments, their carrying amount, and an explanation of why fair value

cannot be measured reliably (HKFRS 7 paragraph 30(b));

• a maturity analysis for issued financial guarantee contracts (HKFRS 7 paragraph 39(a)); and

• a sensitivity analysis for each type of market risk (e.g. other price risk) to which the entity is exposed at

the end of the reporting period, showing how profit or loss and equity would have been affected by

changes in the relevant risk variable that were reasonably possible at that date (HKFRS 7 paragraph

40(a)).

2. HKFRS 8 Operating Segments

The following disclosures were often omitted:

• the judgements made by management in applying aggregation criteria in HKFRS 8 paragraph 12

when the reporting entity had aggregated operating segments. This includes a brief description of

the operating segments that have been aggregated in this way and the economic indicators that

have been assessed in determining that the aggregated operating segments share similar economic

characteristics (HKFRS 8 paragraph 22(aa));

• the identity of the segment or segments reporting the revenues if revenues from transactions with a

single external customer amount to 10 per cent or more of the reporting entity’s revenues (HKFRS 8

paragraph 34);

• the nature of any differences between the measurements of the reportable segments’ profits or losses

and the entity’s profit or loss before income tax expense or income and discontinued operations (if

not apparent from the reconciliations described in HKFRS 8 paragraph 28) (HKFRS 8 paragraph 27(b));

and

• entity-wide disclosures (i.e. information about products and services, information about geographical

areas and information about major customers). The amounts reported in entity-wide disclosures shall

be based on the financial information that is used to produce the entity’s financial statements, rather

than using the management approach. (HKFRS 8 paragraphs 31 to 34).

There was an instance that the reporting entity had reported only one operating segment that was

engaged in manufacture and sales of metal products. During the year, the reporting entity acquired

a group of associates at a significant consideration and the principal activities of the associates were

different from that of the reporting entity. In this case, the auditor should question its client about the


52

basis for determination of operating segments and assess whether the entity’s investment in associates

and its share of results from the associates should be reported under a separate segment (see HKFRS 8

paragraphs 23 and 24) or disclosed as part of the reconciliations of the segment results and assets to the

corresponding amounts of the entity (see HKFRS 8 paragraph 28).

For more information see the alert published in September 2010 concerning the key principles and

application issues of HKFRS 8, available at:

http:/ /www.hkicpa.org.hk/f i le/media/sect ion6_standards/technical_resources/pdf-f i le/

financialauditing/2010/fraa-10.pdf

3. HKFRS 13 Fair Value Measurement

The following disclosures were often omitted:

• information as required by HKFRS 13 paragraph 93, for example:

- for recurring and non-recurring fair value measurements, the fair value measurement at the

end of the reporting period; and the level of the fair value hierarchy within which the fair value

measurements are categorized in their entirety (Level 1, 2 or 3);

- for recurring and non-recurring fair value measurements categorized within Level 2 and Level 3

of the fair value hierarchy, a description of the valuation technique(s) and the inputs used in the

fair value measurement. If there has been a change in valuation technique, a description of the

change and the reason(s) for making it;

- for recurring fair value measurement categorized within Level 3 of the fair value hierarchy, a

narrative description of the sensitivity of the fair value measurement to changes in unobservable

inputs if a change in those inputs to a different amount might result in a significantly higher or

lower fair value measurement; and

- for recurring and non-recurring fair value measurements categorized within Level 3 of the fair

value hierarchy, a description of the valuation processes used (e.g. how an entity decides its

valuation policies and procedures).

4. HKAS 1 (Revised) Presentation of Financial Statements

The following presentation disclosures were sometimes omitted:

• critical judgements applied by management in the process of applying the entity’s accounting policies

(HKAS 1 (Revised) paragraph 122);




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• information about the assumptions that management makes about the future and other major

sources of estimation uncertainty at the end of the reporting period, that have a significant risk of

resulting in a material adjustment to the carrying amounts of assets and liabilities within the next

financial year (HKAS 1 (Revised) paragraph 125);

For example, there were no disclosures of the key sources of estimation uncertainty in relation to a

significant write-down of inventories to their net realizable value.

• the amount of dividends recognized as distributions to owners during the period and the related

amount of dividends per share, presented either in the statement of changes in equity or in the notes

(HKAS 1 (Revised) paragraph 107), e.g. the special dividends distributed during the year;

• the amount expected to be recovered or settled after more than twelve months for each asset and

liability (e.g. properties under development recorded in the consolidated statement of financial

position) (HKAS 1 (Revised) paragraph 61);

• a description of the nature and purchase of each reserve within equity (HKAS 1 (Revised) paragraph

79(b)); and

• the additional information on nature of expenses (e.g. depreciation and amortization and employee

benefits expense) as required by HKAS 1 (Revised) paragraph 104 when the reporting entity classifies

expenses by function.

In addition to the above, we identified instances where exchange differences arising on translation

of financial statements of subsidiaries were presented as an item that would not be reclassified

subsequently to profit or loss in the other comprehensive income section in the consolidated statement

of profit or loss and other comprehensive income. It was however unclear as to how those exchange

differences were derived. Members should note that, if exchange differences relate to a foreign

operation as defined under HKAS 21 paragraph 8, the differences are required to be reclassified from

equity to profit or loss upon disposal of the foreign operation. Therefore members should identify the

origination of the exchange differences in determining their classification in the consolidated statement

of profit or loss and other comprehensive income.

As required by HKAS 1 (Revised) paragraph 17(c), an entity shall provide additional disclosures when

compliance with the specific requirements in HKFRS is insufficient to enable users to understand

the impact of particular transactions. HKAS 1 (Revised) paragraph 112(c) also requires an entity to

provide information that is not presented elsewhere in the financial statements, but is relevant to an

understanding of any of them. Instances were identified where the disclosures were not sufficient to

enable users to understand the transactions, e.g. no disclosures were made to explain the basis for

transferring significant funds from share premium to retained earnings. There were also instances

where there were no disclosures of the nature of the major components of significant balances such as

prepayments and deposits, other payables and accrued charges.


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5. HKAS 17 Leases

The following disclosure was sometimes omitted or incomplete:

• a general description of the lessee’s significant leasing arrangements, including but not limited to, (i)

the basis on which contingent rent payable is determined; (ii) the existence and terms of renewal or

purchase options and escalation clauses; and (iii) restrictions imposed by lease arrangements, such as

those concerning dividends, additional debt and further leasing (HKAS 17 paragraph 35(d)).

6. HKAS 23 (Revised) Borrowing Costs

The following disclosure was sometimes omitted:

• the capitalization rate used to determine the amount of borrowing costs eligible for capitalization

(HKAS 23 (Revised) paragraph 26(b)).



Communication with members

The results of both programmes are communicated to members to improve their understanding and

application of professional standards and raise the quality of auditing and financial reporting. More common

and significant matters found in the review programmes were communicated to members through different

channels:

• The QAD hosted two forums, one in June and one in September 2017, which drew a combined total of

around 530 attendees. The forums covered common findings from practice reviews and recommended

actions that could be taken by practices to enhance audit quality. A webcast of the forum has been

available on the Institute’s website from October 2017.

• On 22 November 2017, the QAD held a joint financial reporting forum with the FRC and HKEX which

drew approximately 280 attendees. The representatives of the three bodies shared common or significant

observations identified from reviews of financial statements of listed companies. A web-cast of the event

has been available on the HKICPA’s website from January 2018.

• The DQA participated in the practice review session of the 2017 SMP Symposium in November 2017

which attracted approximately 310 attendees.

Findings from the reviews have also been used by the Institute’s technical team to provide relevant support

for members through regular technical training sessions.

Members of the Regulatory Oversight Board in 2017

Name Position Company

Ms. BROWN, Melissa Chairman Daobridge Capital(Appointed 1 February 2017)

Mr. TAM Wing Pong Deputy Chairman Retired(Appointed 1 February 2017)

Mr. CHAN, Kam Wing, Clement Member BDO Limited(Appointed 1 February 2017)

Ms. CHUNG, Lai Ling Member Gov’t of HKSAR(Appointed 1 February 2017)

Mr. HO, Chiu Ping, Dennis Member PricewaterhouseCoopers(Appointed 1 February 2017)

Miss KWAN, Angelina Member Hong Kong Exchanges and Clearing (Appointed 1 February 2017) Limited Mr. LAM, Chi Yuen, Nelson Member Nelson Consulting Limited(Appointed 1 February 2017)

Ms. LAU, Wai Yin, Susanna Member Securities and Future Commission(Appointed 1 February 2017)

Mr. POGSON, Timothy Keith Member Ernst & Young(Appointed 1 February 2017)


Annex

Annex


Members of the Practice Review Committee in 2017


Ms. YAM, Hoi Yin, Cecilia Chairman BDO Limited

Mr. HEBDITCH, Paul Donald Deputy Chairman Ernst & Young

Mr. BROADLEY, Derek Thomas Member Deloitte Touche Tohmatsu(Appointed 1 February 2017)

Mr. CHAN, Shu Kin, Albert Member Ting Ho Kwan & Chan

Mr. CHAN, Tze Kit Member Grant Thornton Hong Kong Limited(Appointed 1 February 2017)

Miss CHAN, Wai Ching Member PricewaterhouseCoopers

Mr. FAN, Chun Wah, Andrew Member C.W. Fan & Co. Limited

Mr. LAI, Tak Shing, Jonathan Member HLB Hodgson Impey Cheng Limited

Mr. LIU, Eugene Member RSM Hong Kong / RSM Nelson Wheeler

Mr. LO, Charbon Member CCIF CPA Limited /(Appointed 1 February 2017) Crowe Horwath (HK) CPA Limited

Miss NG, Shun Yin Member KPMG

Mr. OR, Ming Chiu Member Mazars CPA Limited

Mr. PANG, Wai Hang Member SHINEWING (HK) CPA Limited(Appointed 1 February 2017)

Mr. WONG, Ho Yuen, Gary Member

Mr. YAU, Yin Kwun, Joseph Member C K Yau & Partners CPA Limited

Annex


Members of the Professional Standards Monitoring Expert Panel in 2017


Mr. DEALY, Nigel Derrick Member PricewaterhouseCoopers

Mr. HEBDITCH, Paul Donald Member Ernst & Young

Miss HSIANG, Yuet Ming, Fanny Member BDO Limited

Mr. KWONG, Kam Wing, Kelvin Member Grant Thornton Hong Kong Limited

Mr. LAI, Tak Shing, Jonathan Member HLB Hodgson Impey Cheng Limited

Mrs. MORLEY, Catherine Susanna Member KPMG

Mr. ONG, Wei Dong Member Hong Kong Exchanges and Clearing Limited(Appointed 1 February 2017)

Mr. PANG, Wai Hang, Arthur Member SHINEWING (HK) CPA Limited

Mr. STEVENSON, James Gary Member RSM Hong Kong

Mr. TAYLOR, Stephen Member Deloitte Touche Tohmatsu

This Annual Report is intended for general guidance only. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this Annual Report can be accepted by the Hong Kong Institute of Certified Public Accountants.

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